|R. C. Sharma (AM), Vivek Varma (JM)
|location savings adjustment, risk adjustment, Transfer Pricing
|Karishma R Phatarphekar
|January 9, 2015 (Date of pronouncement)
|January 12, 2015 (Date of publication)
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|Transfer Pricing: Law on making adjustments for 'risk' and 'location savings' explained
(i) On the issue of risk adjustment, detailed analysis had been provided. The AR submitted that The assessee being a captive service provider hence undertakes lesser risk as compared to comparable companies which undertakes higher risk. This fact has not been disputed by the revenue authorities. Mumbai Bench of Income Tax Appellate Tribunal in the case of Symatec (supra) contemplates the standard deduction of 5% for risk adjustment. However, if not 5% then risk adjustment upto 2.25% which is the difference between Bank Fixed deposit rate (which undertakes little more risk) and risk free government bond (which undertakes risks) should be allowed.
(ii) The assessee as well as the AE operates in a perfectly competitive market and the assessee does not have exclusive access to the factors that may result in the location specific advantages. As a result, there is no super profit that arises in the entire supply chain. Thus there is no unique advantage to the assessee over competitors. We are basing our opinion on the fact that the revenue authorities were not able to substantiate the adjustments made either from the present day scenario or any authenticated and globally material.
(iii) The comparables selected by the assessee to determine arm’s length price of transaction relating to contract manufacturing and contract research and development are local Indian comparables operating in similar economic circumstances as the assessee. This according to us are in line with the decision of coordinate bench of the ITAT, Delhi, in the case of GAP International Sourcing (India) Pvt. Ltd. (supra), wherein the Tribunal held, “The arm’s length principle requires benchmarking to be done with comparables in the jurisdiction of tested party and the location savings, if any, would be reflected in the profitability earned by comparables which are used for benchmarking the international transactions. Thus in our view, no separate/additional allocation is called for on account of location savings”.
(iv) OECD and G20 in Action 8: Guidance on Transfer Pricing Aspects of Intangibles which is part of Base Erosion and Profit Shifting Project, has provided guidance on issue of location savings and concluded that where local market comparables are available specific adjustment for location saving is not required. All the G20 countries have give their concurrence to this position and India is part of G20 countries.
(v) The calculation based on location savings by TPO is also infirm, as it is based on assumptions and not in accordance with the provisions of the Income Tax Act, 1961, because for computing cost savings TPO has relied on an article published in year 2012 whereas assessee’s case is for Financial Year 2008-09. Therefore interpolation cannot be taken into consideration, unless specified.
(vi) Once the TNMM method is accepted as method of considering assessee as a tested party then any benefit/advantage accruing to AE is irrelevant if the PLI is within the range of comparables.
(vii) We also take into consideration the reliance placed on UN TP Manual by the TPO, about which we are convinced was incorrect reliance, because UN Manual, is basically view of Indian tax administration and is not binding on Appellate authorities.
(viii) Last but not the least, the TPO has based his computation on a method, which is not ascribed by the provisions of the Act. No doubt, clause (f) of section 92C(1) says, “such other method as may be prescribed by the Board”. For adoption of this method, the TPO has to take care that the method has to be prescribed by the Board, which can do so through relevant Rules. Even relevant Rules do not talk about the method adopted by the revenue authorities. This, in unison with the decision of the coordinate Bench on incorrect method of computation, we are of the view that the TPO/AO and DRP erred in making the adjustment on account of location savings.