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Transfer Pricing: Automatic RBI approval means transaction is at Arms Length Price

CLR Editorial Notes: The IT Appellate Tribunal had to consider two legal issues in the context of transfer pricing in this case.

(i) whether a royalty agreement falls within the ˜automatic approval scheme™ and is approved or deemed to be approved by the RBI, and if so, whether the royalty can be treated to be at arms™ length;

(ii) what are the parameters to be applied while applying Internal TNMM.

The Tribunal held:

(i) The assessee™s collaboration agreement with its AE for payment of 2% of contract value for manufacturing, drawing and engineering services and 5% of the selling price as royalty falls under the automatic approval scheme of the RBI. When the rate of royalty payment and fee for drawings etc. has been approved or deemed to have been approved by the RBI, then such payment has to be considered at ALP;

(ii) Rule 10B(1)(e)(i) requires the profit margin realised by the enterprise from an international transaction entered into with an AE to be ascertained for determining as to whether or not it is at arm™s length. The margin with which such margin earned by the assessee is compared with for determining the ALP, can be internally available from comparable transaction(s) or from externally available cases. If the enterprise has entered into similar transactions with third parties as are under consideration with the AE, then the profit realized from such transactions with third parties is a good measure to benchmark the margin from international transaction. Thus, on one hand we need to have profit margin which is to be compared from transactions with the AEs and on the other hand, we need to find out the profit margin from similar transactions with non-AEs with which comparison is to be made. Both these figures should come from separate watertight compartments. No overlapping is permissible in the composition of such compartments. In other words, neither the first compartment of profit margin from AE transactions should include profit margin from the transactions with non-AEs, nor the second compartment should have profit margin from the transactions with the AEs. If such an overlapping takes place, then the entire working is vitiated, thereby obliterating the finer line of distinction of the profit margin to be compared and the profit margin to be compared with. On facts, as the assessee had not maintained segment-wise accounts and as the figures of AE and Non-AE transactions were segregated from the common pool of figures, the margins derived therefrom were not reliable and the claim of internal TNMM was not acceptable.

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The case file is available for download

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