Rule 10B of Income Tax Rules provides methodology for computation of ALP. Under TNMM, ‘net profit’ is used as benchmark for ALP computation. Rule 10B(1)(e)(i) provides for considering “net profit margin realised by the enterprise from an international transaction or SDT entered into with an associated enterprise”. Rule 10B(1)(e)(ii) provides for computation of ‘net profit margin in uncontrolled comparable transactions’. Therefore, while computing net margin realized by the enterprises (tested party as well as comparables) all incomes and expenses that are representative or comprised of business obligation should be considered.
Before the Courts, the issue came up whether compensation paid by the taxpayer for closure of certain business units can be considered as abnormal expense and therefore non-operating in nature for computing ALP. Generally, compensation for business closure would not relate to regular operations of the company and should be treated as operating in nature. The following cases have dealt with this issue.
Marubeni India (P.) Ltd. v Director of Income-tax [2013] 33 taxmann.com 100 (Delhi HC) – – The taxpayer, a private limited company, was engaged in two business operations consisting of representation service, to liaise between the business divisions of MCJ and its various suppliers/customers in India and trading of a broad range of industrial, agricultural and consumer goods, commodities and natural resources. The taxpayer had incurred certain amounts towards compensation for closure of some branches. The taxpayer contended that same is abnormal in nature and should not form part of operating cost while computing ALP. The TPO and CIT(A) held that same is operating in nature on the ground that the taxpayer is contract service provider and closing offices would reduce the cost of the AE and the taxpayer should be compensated for such closure.
The ITAT (Marubeni India Pvt. Ltd. v DCIT (2012) 15 ITR (TRIB) 0297, (2012) 144 TTJ 0474 (Delhi ITAT))observed that the compensation for closure of certain units may not be a regular phenomenon. However, by closing down certain branches, taxpayer has reduced the cost of AE. Taxpayer has been receiving certain charges at cost plus 10 per cent. It means that closure has a direct link with the international transaction. The ITAT held that therefore, this type of expenses would always be considered as operating in nature. Taxpayer filed an appeal to High Court. The High Court observed that ITAT and CIT(A) have failed to keep in mind that even according to the AO, the taxpayer was being compensated for its agency and market support service by way of handling commission and fixed service fee. The HC held that taxpayer is not compensated at cost plus 10%. The HC observed that it seems rather remote that considering the nature of the remuneration received by the taxpayer from its AE, the payment of compensation on closure of the Indian offices would have any impact on the transfer pricing issue or in the fixing of the ALP. The High Court held that having regard to the nature and manner in which the taxpayer is remunerated for its services, the payment of compensation to the Indian units on their closure would represent abnormal costs, which have to be excluded in the determination of the ALP.