Transfer Pricing: If more than one price is determined by the most appropriate method, the ALP has to be the arithmetical mean of such prices

CIT vs. Mentor Graphics (Noida) Pvt. Ltd (Delhi High Court)

The assessee was engaged in providing “software development support services” by which it developed software upon the instructions of its parent associated enterprise (IKOS Systems Inc). The entire software developed by the assessee was used by the parent AE captively for integrating the same with other software components developed by it. The assessee adopted the TNMM and claimed that its transactions were at ALP. The TPO rejected the assessee’s comparables on general grounds and selected his own comparables and used figures for a subsequent year. He determined the ALP at a much higher figure and made an adjustment. On appeal by the assessee, the Tribunal held that the criteria adopted by the TPO for searching comparables was not correct. It held that the TPO was wrong in selecting his own comparables without first rejecting the assessee’s comparables. It also held that where one of the prices determined by the most appropriate method is less than the price as indicated by the assessee, that may be selected and there would be no need to adopt the process of taking the arithmetical mean of all the prices arrived at through the employment of the most appropriate method. On appeal by the department to the High Court, HELD:

The Tribunal was wrong in holding that if one profit level indicator of a comparable, out of a set of comparables, is lower than the profit level indicator of the taxpayer, then the transaction reported by the taxpayer is at an arm’s length price and there is no need to take the arithmetical mean. The proviso to s. 92C(2) is explicit that where more than one price is determined by most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices. The Tribunal was also wrong in the finding that unless and until the comparables drawn by the taxpayer were rejected, a fresh search by the TPO could not be conducted because s. 92C (3) which stipulates four situations where under the AO/ TPO may proceed to determine the ALP in relation to an international transaction. If any one of those four conditions is satisfied, it would be open to the AO/ TPO to proceed to determine the ALP price. Also, the question of applying OECD guidelines does not arise at all because there are specific provisions of Rule 10B (2) & (3) and the first proviso to s. 92C(2) which apply. The Tribunal was also not right in reducing the list of comparables to merely four. Having held that the comparables given by the assessee were to be accepted and those searched by the TPO were to be rejected, the only option then left to the Tribunal was to derive the arithmetical mean of the profit level indicators of the comparables which were accepted by it. It erred in selecting only one profit level indicator out of a set of profit level indicators. However, on facts this make no difference because even if the arithmetical mean of the comparables as accepted by the Tribunal are taken into account, the profit level indicator would be less than 6.99 % which is the profit level indicator of the assessee.