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Arms Length Pricing – Adjustment cannot be made to the entire entity turnover/ profits

Ratio of the Case: With relation to the Transfer Pricing regime, Arms Length Pricing should be determined on segment-wise profits & not at an entity level. In such a case, adjustments cannot be made to the entire entity turnover or profits.

CLR Editorial Notes: The assessee had entered into several international transactions with its Associated Enterprise and claimed that there operations were being conducted at arm™s length on the basis of a segment-wise, using Transactional net margin method analysis for each of the transactions. The Transfer Pricing Officer (TPO) rejected this claim, on the grounds that the segment-wise accounts had not been audited.

The TPO had adopted an entity method approach for the purpose of determining the Arms Length Pricing. While doing this calculation, the TPO rejected the segmental analysis undertaken by the assessee. The TPO instead accepted 4 segments of the assessee™s operations and identified the comparables and arrived at a different arithmetical means of appropriating profit level indicators. He did it by taking operating profit by cost of various identified comparables in each segment.

Thereafter, the TPO arrived at the operating profit at 18.09% at entity level, using a weighted average method to assess the percentage of turnover out of the total turnover and hence determined the weighted average of the arithmetic mean from within each segment. It was this amount that was taken as the arm™s length profit margin. As the assessee™s operating margin was less than the calculate Arms Length Pricing, an adjustment of a large sum of money to the tune of Rs. 82 crore was made to the assessee™s income.

The Assessee furnished segment wise audited  accounts, the DRP ignored the same. The Assessee appealed to the Tribunal which held:

As the assessee™s operates in four different & independent segments and it submitted segmental accounts for each of its operation, the correct approach under Transactional net margin method should be to determine the Arms Length Pricing of each of the segments by comparing with the corresponding comparables involved in similar lines of functioning after proper FAR analysis. As the TPO had details of each segment-wise profit margin of the comparables, he ought to have compared the relevant profit margins with that of the assessee™s profit margins in each segment. His approach of taking the weighted average method of arriving at entity based profit margin is not correct. Also, his approach of making the adjustment on the entire turnover of the assessee including transactions with non-AEs instead of restricting it to the AEs™ transactions is not supported by the transfer pricing provisions. Further, in arriving at the segment-wise profit margin, the TPO should carry out an analysis of each company™s business activity, why they are selected as comparable and what are the functions of the company, operating margins, etc. He should adopt proper parameters/filters in respect of each segment. If the assessee opposes the selection of comparables by the TPO, it is the responsibility of the TPO to furnish necessary details. The onus cannot be shifted to the assessee when it is contending that proper data is not available in public domain in this regard.

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The full case file is available for download

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Tags: ALPArm's length principleCommonwealth Law ReportsTPOTransactional Net Margin Methodtransfer pricing

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