- Rejected the tax authorities’ contention that economic adjustments may only be computed with respect to margins of comparables
- Held that the taxpayer’s profit margins in future years were not to be included in calculating the arm’s length price (even though the earning of profit by the taxpayer in two years subsequent to the tax year could justify the loss for the year at issue)
- Held an adjustment for differences in the working capital position was only permissible when the requirements under Rule 10B(1)(e) were met
The taxpayer manufactured water heaters. The year at issue was the taxpayer’s first year of operations.
The taxpayer sold water heaters and spare parts to a related party; however, because this was the first year of operations, the taxpayer was able to use only 21% of its installed capacity.
The taxpayer determined the arm’s length price of its international transactions using the Transactional Net Margin Method (TNMM), and compared its profit margin (after excluding fixed costs related to its start-up phase and un-utilized capacity) with unrelated comparables. The taxpayer then concluded that its international transactions were at arm’s length, after giving consideration to economic and commercial factors.
The Transfer Pricing Officer (subsequently upheld by the Dispute Resolution Panel) made a transfer pricing adjustment and:
- Denied the taxpayer’s economic adjustments, finding that such adjustments are only allowed on the margins of comparables
- Rejected the use of multiple-year comparable data
- Changed the profit-level indicator from operating profit / operating sales to operating profit / total costs
The tribunal agreed with the taxpayer and allowed the capacity under-utilization adjustment claimed by the taxpayer. The case was returned to the Assessing Officer with instructions to verify the material submitted on capacity utilization of the comparables.
Concerning the use of the two subsequent years of profitability, the tribunal agreed with the tax authorities that even though the taxpayer realized a profit in those two subsequent years, there was no justification for including the future years’ profit margins in determining the arm’s length price.
Thus, the tribunal provided a justification for computing an economic adjustment for differences between the tested party and comparables on the profit margins.
Read an August 2013 report [PDF 326 KB] prepared by the KPMG member firm in India:
Pune Tribunal held that capacity under-utilization adjustment can be claimed on the profit
margin of the tested party so as to facilitate comparison with comparable uncontrolled entities
Contact a tax professional with KPMG's Global Transfer Pricing Services.