India: Mumbai Tribunal Ruling On The Application Of Comparable Uncontrolled Price Method And Resale Price Method To Determine The Arm's Length Price

Last Updated: 26 January 2010
Article by Vispi T. Patel

Gharda Chemicals Ltd. V. DCIT (Mum) (2009-TIOL-790-ITAT-MUM)


Gharda Chemicals Ltd. ("GCL India "/ "the assessee"), a company incorporated in India, was engaged in manufacturing of fertilizers and chemicals. Since direct export to USA was not permissible and in order to overcome this difficulty and keeping into consideration the business interest, the assessee had set up its wholly owned subsidiary, Gharda USA Inc. ("Gharda USA" / "WOS") in USA.

During the FY 2001-02, GCL India had exported Dicamba to its associated enterprise ("AE"), Gharda USA at USD 14.66 per kg. The assessee had determined the Arm's Length Price ("ALP") by applying the Comparable Uncontrolled Price method ("CUP" method). GCL India also exported Dicamba to third parties located in non-US countries viz. UK, Netherlands, New Zealand, Australia, France, etc. at the rates ranging between USD19.47 to USD 25.00 per Kg. The total quantity exported by the assessee to different countries was 418,803 Kgs. inclusive of 272,100 Kgs. sold to its AE. The Transfer Pricing Officer ("TPO") determined the average rate of sale to all independent enterprises at USD 20.67 per Kg., which was found to be substantially higher than USD 14.66 per kg charged by the assessee from its AE. On being show caused as to why the average rate of USD 20.67 per kg be not applied in respect of sale to AE, the assessee furnished a report of an external expert, which indicated that the price charged by the assessee from its AE was higher than the price charged by China from similar goods exported to USA to some other party. The TPO observed that there was no authenticity of the report of the external expert as no reliable data was considered by him for his this purpose. Even credentials of the external expert were doubted as it was not known that in which capacity he was making such report. In the light of these facts, the TPO came to the conclusion that the External CUP, being the report of the external expert could not be considered in preference to the Internal CUP, being the price at which the assessee sold the goods to other unrelated parties in several other countries. The TPO also rejected the assessee's alternative submission for adoption of "Resale price method" for calculating ALP. The TPO determined ALP at USD 19.587 per kg after reducing USD 2.03 per kg on account of selling and distribution expenses along with geographical differences and further increased the same by USD 0.92 per kg on account of freight differential and excess credit period. This resulted into an addition of Rs. 6.44 crores.

The Commissioner of Income tax (Appeals) ["CIT(A)"] also confirmed the order of the TPO. The assessee had, therefore preferred an appeal to the Income tax Appellate Tribunal ("ITAT").

Contention of the Assessee before the ITAT:

  • GCL India had floated a WOS in USA only for the fact that direct export was not allowable in USA.
  • The ALP had been determined on the basis of the report of a third party expert and the same deserves to be accepted.
  • GCL India sold Dicamba to Gharda USA on a wholesale basis whereas it sold Dicamba around 35% of the total quantity to independent third parties in non-US countries on a retail basis. Therefore, Internal CUP should be rejected as the most appropriate method to determine the ALP.
  • AE was a loss making entity and the export of Dicamba to AE at USD 14.66 per kg did not result into lowering of the tax incidence on the fact that if higher prices would have been charged from AE, that would have resulted into further losses in the hands of AE and there is no ultimate effect on the tax liability of GCL India, when considered in totality along with its AE.
  • The entire exercise of determining ALP of the transactions between the two enterprises is useless as the price charged or paid by one enterprise to another AE is tax-neutral on totality, therefore, is sans merit.
  • It was submitted that instead of CUP, the Resale Price Method should be considered as the most appropriate method to determine the ALP as the ALP cannot be ascertained at an exorbitant figure in disregard to stark reality of there being a loss in the hand of AE.

Contention of Revenue before the ITAT:

  • The Internal CUP method pressed into service by the TPO was most appropriate in this case and there was no need for relying on External CUP method as the external evidence, being the report of external expert was not reliable for several reasons.
  • There was no material to indicate as to whether the external expert, being a private individual claimed by the assessee as expert in this field, was even competent to issue such report, which, in turn, was in the nature of a self serving evidence.
  • The price stated in the report was not backed by any data from some Government agency in USA. It was pointed out that the external expert took into consideration only certain instances of import made by one USA party from China which was inappropriate in as much as it was imperative to consider the import price of Dicamba in relation to all the parties in USA so as to determine the correct and fair ALP of the transaction between assessee and AE. Since the assessee had itself effected exports to other countries, the ld. D.R stated that the price charged from other unrelated customers threw a proper light on the correct ALP which would have been charged by it from its AE.

ITAT's observations and the ruling:

Application of Provision of Sec 92CA

The argument that the transfer pricing provisions are not applicable in view of the total incidence of tax remaining at the same level due to losses incurred by AE offsetting the income of the assessee, does not merit acceptance. The intent and purpose of these provisions are not to ensure that there is no diminution in the tax liability of Indian Enterprise as well as its AE on a total basis. Rather the logic is to make certain that the transactions between the AEs should not be arranged in such a way that the ultimate tax payable in India is artificially reduced. What is material is that the rightful tax payable in India should not suffer due to the adjustment of price for goods or services between the related enterprises.

The payment of tax by the AE abroad does not contribute anything to the Indian exchequer. Important factor is the payment of tax qua India and not qua the assessee along with its AE on a whole. If the assessee's total tax liability logic is accepted, it would render the provisions of Sec 92 to 92F redundant.

Resale Price Method

The Resale Price method is applicable with reference to the property purchased or services obtained by an enterprise from its AE, which is thereafter resold or are provided to the unrelated enterprise. It shows that if the Indian Enterprise purchases goods or obtains services from its AE in an international transaction, then the ALP shall be determined by adjusting the price at which the property is purchased or services are obtained by the Indian Enterprise.

In the instant case, the property is sold and not purchased by the Indian Enterprise from its AE abroad and therefore, ex-consequenti the Resale Price method cannot be invoked in the hands of the assessee in India for the determination of ALP. If the situation had been otherwise that the assessee had purchased the goods from its AE situated in USA, then this method could have been invoked for determining the ALP. For these reasons, the ITAT has held that the Resale Price method is not even appropriate, what to talk of the "most appropriate method" for determining of ALP in the present international transactions.

CUP Method

The CUP method is applicable both in the cases where property is purchased or sold. The only requirement is that the price which is charged or paid in comparable uncontrolled transaction should be adjusted to account for differences.

The price charged by an Indian party from UK or Australia may be at much variance with that charged from USA. In such a scenario no valid comparison can be made between the price charged by the assessee from other countries with that from USA, more particularly when the quantity exported to the USA is on wholesale basis with that to other countries in small lots on retail basis. The Internal CUP method is not suitable in the present circumstances.

The External CUP method contemplates comparison of the price charged by the assessee from its AE with that at which the goods are available in the open market in that country from transactions between the unrelated third parties. With a view to determine the price at which such goods are available in the open market in that country, it is sine qua non to consider the price at which such goods are imported by other parties on an average basis. Such an average price should be some realistic price representing the price from the whole or the large part of whole of the imports made in USA of this product and not some isolated or a stray transaction. The third party report cannot be the sole basis for determining the ALP on comparable uncontrolled price method for the reason that the third party is not a Government Agency of USA, which could vouch for the price at which Dicamba is imported in USA from various countries. The third party, in turn, had relied on certain stray instance of importing Dicamba from China. Reliance on such selective data cannot be a best guide for the determination of ALP.

Matter Restored to the Assessing Officer

The assessee placed on the record at the time of hearing before the Tribunal certain data from the Government of USA agency relevant for determining ALP of Dicamba, as additional evidence.

Since the lower authorities have gone by the determination of ALP on the basis of Internal CUP method, which is not appropriate in the opinion of the ITAT, the matter has been set aside to the Assessing officer by directing him to get the fresh ALP determined from the TPO after allowing the assessee fresh evidence in support of its case.

Our View:

This judgement clearly brings out the importance of the most critical element of any transfer pricing analysis, i.e. the use of comparable data for the purpose of benchmarking the controlled transaction. Further, it emphasizes that the standard of the comparable data while applying the CUP method is more stringent and need of similar economic relevant transactions is of paramount importance. Mere product similarity is not sufficient for applying the CUP method, unless the economic circumstances surrounding the transaction is also similar.

Further, the reasoning behind the rejection of the Resale Price Method, and the ITAT's conclusion with regard to its applicability only from an Indian Transfer Pricing perspective, in our humble submission, needs reconsideration, as application of any of the specified methods under section 92C is not restricted to the Indian Enterprise, being the tested party, and the Foreign AE can also be a tested party for the purpose of comparability analysis.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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