Facts of the Case

The present appeals were filed by the Revenue against separate orders of the Income Tax Appellate Tribunal (ITAT) for Assessment Years 2007-08, 2008-09, and 2009-10.

The Assessee, ITOCHU India Private Limited, is a wholly owned subsidiary of Itochu Corporation, Japan, engaged in providing support services including facilitation and market support to its Associated Enterprises (AEs) for sourcing transactions.

The dispute centers around the determination of Arm’s Length Price (ALP) for international transactions undertaken by the Assessee.

Issues Involved

  1. Whether the Transfer Pricing Officer (TPO) was justified in including FOB value of goods sourced by AEs while computing operating cost under the Transactional Net Margin Method (TNMM).
  2. Whether the TPO could enhance the cost base by imputing costs of third parties for determining ALP.
  3. Whether the ITAT was correct in deleting the transfer pricing adjustment made by the TPO.

Petitioner’s Arguments (Revenue)

  • The Revenue contended that the ALP determination should include FOB value of exports made to third parties.
  • It was argued that the TPO correctly applied a mark-up on such value to determine the Assessee’s profit margin.
  • The Revenue challenged the ITAT’s reliance on earlier judgments and sought reconsideration of ALP computation methodology.

Respondent’s Arguments (Assessee)

  • The Assessee argued that under TNMM, only its own costs should be considered, not costs incurred by third parties or AEs.
  • It relied on judicial precedent stating that inclusion of FOB value artificially inflates the cost base.
  • It was contended that the TPO wrongly recharacterized the Assessee’s role from a service provider to a trader.

Court’s Findings / Order

  • The Court upheld the ITAT’s order and dismissed all appeals filed by the Revenue.
  • It relied on the precedent laid down in Li & Fung India Pvt. Ltd. v. Commissioner of Income Tax (2014) 361 ITR 85 (Del).
  • The Court held that under TNMM, profit margin must be computed only with reference to the Assessee’s own costs and not costs of third parties.
  • Inclusion of FOB value of goods sourced by AEs in operating cost was held to be unsustainable in law.
  • The Court also affirmed that the TPO had wrongly enhanced the cost base and incorrectly recharacterized the business model.
  • It concluded that no substantial question of law arose in the matter.

Important Clarifications

  • TNMM must be applied strictly in accordance with Rule 10B(1)(e), focusing only on the Assessee’s financials.
  • Artificial inflation of cost base by including FOB value or third-party costs is impermissible.
  • Recharacterization of business model by TPO without legal basis is not sustainable.
  • Consistency principle: Acceptance of ALP in subsequent assessment years strengthens the Assessee’s case.

Sections / Provisions Involved

  • Section 92C of the Income Tax Act, 1961
  • Rule 10B(1)(e) of the Income Tax Rules, 1962 (Transactional Net Margin Method – TNMM)

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2019:DHC:7399-DB/SMD13052019ITA11112018_155021.pdf

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