C.L. Sethi, Judicial Member. - The assessee is in appeal against the order dated 29-11-2007 passed by the ld. CIT(A) in the matter of an assessment made under section 143(3) of the Income-tax Act, 1961 ("the Act") pertaining to the assessment year 2003-04.

2. The grounds of appeal raised by the assessee are as under:—

"1. The ALP (arm’s length price) fixed at Rs. 4,21,83,057 is not justified.

2. The fixation of ALP at TNM (transactional net margin) based on the arithmetical means of the profits of other companies is incorrect.

3. The ALP based on uncontrolled prices paid by the AE (associated enterprise) for goods supplied to the appellant company ought to have been adopted.

4. Without prejudice to the grounds above, the TNM analysis for arriving at the arithmetical mean of the profits of other companies for the current year alone has disregarded wide fluctuations in profit margins of respective companies from year to year in contravention of the proviso to Rule 10B(4).

5. Without prejudice to the grounds above, differences in operating environment and margins of individual companies have been disregarded in contravention of Rule 10B(3) in the TNM analysis for arriving at the arithmetical mean of the profits of the other companies.

6. Without prejudice to the grounds above, the learned Commissioner of Income-tax (Appeals) XX has erred in holding that compensation of 8.27 per cent to AE for its services cannot be considered for determination of ALP in the absence of compatibility analysis in disregard to the considerations of reasonableness with reference to functions performed, responsibility, risks and benefits divided between the respective parties to the transaction."

3. The assessee-company was incorporated on 11-9-2001 to manufacture printed circuit boards for consumer durations. Commercial production commenced on 1-1-2002. The shareholding of the assessee-company is as under:

4. As stated above, the assessee is engaged into manufacturing of printed circuit boards for consumer durations. Raw material for production of printed circuit boards is both imported and procured indigenously. As per the details submitted by the assessee, the percentage of imported and indigenous raw material is 45.51 per cent and 54.49 per cent respectively. The following international transaction has been undertaken by the assessee:—

5. The bulk of international transactions undertaken by the assessee is purchase of raw material worth Rs. 4.75 crores, which is used in manufacturing of printed circuit boards.

6. For the purpose of determining the arm’s length price by TNM method, the assessee, in its transfer price report, mentioned eight comparable finalization data, which were pertaining for the year 2003, is as under :—

7. The Assessing Officer referred the matter to the TPO (Transfer Pricing Officer) for determining the arm’s length price under section 92A(3) in respect of international transaction entered into by the assessee with associate enterprises during the year under consideration. The TPO after analyzing transfer pricing report submitted by the assessee, has made adjustment to the extent of Rs. 53,70,963 to the price of raw material imported by the assessee from associate concerns. The material portion of TPO’s order is as under:—

"The search criteria has been depicted by the assessee in the transfer pricing report in a summary manner. Companies which had high negative net margins were stated to be excluded from the list of comparables chosen. However, a closer look at the Operating Margins of the comparables for the year 2003 shows that two comparables namely Hyderabad Flextech Limited and Sanmar Micropak Limited had high negative margins. However, the assessee has itself stated that for the purposes of calculating average margin. Hyderabad Flextech has not been considered. It has not made any mention of Sanmar Micropak Limited on this account. An analysis at this end reveals that Sanmar Micropak Limited also has negative net worth in the year under consideration. This is akin of a company with dwindling profitability and hence is outside the purview of comparability.

The assessee-company was confronted with these facts vide order sheet entry dated 27-2-2006. It has been argued during the course of discussions that this company has shown positive results in the earlier years and as such it cannot be rejected. However, the comparability is in the year under audit and the data for this year has been submitted by the assessee hence Sanmar Micropak is excluded from the list of comparables for making this analysis.

The assessee-company also argued that without prejudice to the above, even if Sanmar Micropak is excluded the performance of the assessee would still be within the 5 per cent tolerance band. This is a factual aberration and is not correct as shown in the later part of the analysis hereafter. In view of these discussions, the final list of comparables is as under :—

The operating profit margin of the assessee has been stated to be at 1.65 per cent in the transfer pricing report. The assessee was asked to explain the working of this margin. The counsel of the assessee has explained the working out this margin as under : —

In view of the above discussion, the assessee on comparability analysis on Transactional Net Margin Method is expected to have an operating margin of 5.29 per cent.

Determination of Arm’s Length Price

This difference of Rs. 53,70,963 is to be adjusted on the import price of raw material which means that the import price has to be lowered by this amount.

Since the price paid to the Associated f Enterprise for import of raw material has been breached the limit available to the assessee in the tolerance band specified in the Proviso to section 92C(2) of the Income-tax Act, the Arm’s Length Price of purchase of raw material shall be taken at the arithmetic mean. The Assessing Officer shall, accordingly, increase the income of the assessee by an amount of Rs. 53,70,963. No adverse inferences drawn in respect of the other international transactions for this year."

8. In the light of the TPO’s order, the Assessing Officer made addition of Rs. 53,70,963 by disallowing the cost of raw material imported by the assessee from associate concerns, and added the same to the total income of the assessee.

9. Being aggrieved, the assessee went in appeal before the CIT(A). The CIT(A) confirmed the Assessing Officer’s order by holding that the TPO was justified in taking arm’s length price at the arithmetical meaning of prices without allowing any reduction up to 5 per cent.

10. Still aggrieved, the assessee is in appeal before us.

11. The ld. counsel for the assessee has reiterated the submissions and contentions that were made before the CIT(A), and submitted that the CIT(A) has not been justified in confirming TPO’s order where arm’s length price was determined on TNM method instead of a correct method of making comparable analysis of purchase prices of typical items by associate enterprise from unrelated foreign vendors. He further submitted that the TPO has not considered the individual price of various items but rather cases he went on to apply the average net profit margins of the comparable. He, therefore, submitted that if individual prices of various items are considered rather than going in for the average net profit margins of the comparables, no adjustment to the cost paid by the assessee to associate concerns would be called for. An alternative contention was also made by the assessee that even otherwise if TNM method is applied on the adjustment to the cost price, it can only be applied to the imported goods which comprises only 45.50 per cent of the total purchases, and, therefore, applying the operating profit of 5.29 on total sales of Rs. 14,75,64,045, is not justified. The operating profit @ 5.29 per cent at best be applied only to the proportionate sales made out of raw materials imported from the associate concerns and not in respect of total sales of manufactured items which were manufactured from the raw materials procured by way of import as well as indigenously.

12. The ld. DR on the other hand, supported the order of the authority below.

13. It is not in dispute that II Jin Electronics Ltd., Korea was established in 1978 and it is incorporated entity registered in Korea and is a resident of Korea for tax purposes, II Jin Electronics Ltd., Korea, is one of principal vendor to LG Electronics Ltd. in Korea, and it supplies printed circuit boards to the factories of LG Electronics Ltd. in Korea and Thailand. The majority of shares of ILNLG Korea are with Mr. Yong Joo Sim, and Yong Geun Sim, who also hold majority stacks in the present assessee-company viz., IL JN Electronics India Pvt. Ltd. The present assessee has only one customer viz., LG Electronics India, and the assessee-company can be called a captive vendors for LG Electronics India. The associate concern of the assessee is also one of principal vendors to LG Electronics in Korea and Thailand. The item supplied by the assessee and its associate concern to LG Electronics is also same being the supply of printed circuit boards. The business of the assessee in India is closely connected to the business activities to its associates in Korea and Thailand. The assessee has not procured any raw material from any other entity situated in Korea or Thailand. The comparable transactions has not been carried out by the assessee with any third party in respect of the raw materials, which have been import by the assessee from its associate concerns. The assessee has itself obtained Transfer Pricing Report at TNMM method and the particulars supplied by the assessee itself in its Transfer Pricing Report has been used by the Transfer Pricing Officer while determining the net margin of profit in respect of the transactions undertaken by the assessee with his associate concerns in Korea and Thailand. The assessee’s contention that the Transfer Pricing Officer should have considered the individual price of various items as paid by the assessee’s associate enterprises to its unrelated vendors and should have taken into account the margin of profit earned by its associate concerns on the raw materials procured by them from their vendors and supplied to the assessee. However, all these details are not sufficient to determine the arm’s length price with reference to the individual price of various items inasmuch as the assessee has not submitted any details about price at which the assessee’s associate concerns for supplied the raw materials to another unrelated customers so as to compare price charged by the assessee’s associate concerns from its unrelated buyers with the price charged by the assessee’s associate concerns from the assessee. Insofar as determination of mean of profit by Transfer Pricing Officer, the ld. counsel for the assessee has not been able to point out any irregularity or discrepancy in the report submitted by the Transfer Pricing Officer. Whatever objections has been raised by the assessee with regard to the some comparable to determine the mean of profit, the Transfer Pricing Officer has taken into account and has excluded those concerns which were objected to by the assessee and not relevant for determining the mean of profit. It is further seen that in subsequent assessment year 2004-05, and, thereafter, the assessee has applied the same TNMM, though on merit having regard to the net margin of profit earned by the assessee as compare to the net margin of profit of comparables, no adjustment was called for. In other words, the TNMM method applied in this assessment year has been accepted by the assessee as well as by the department in subsequent assessment year insofar as the facts of the present case are concerned. Having regard to the facts and circumstances, and absence of sufficient materials and evidences to apply another method, we are in full agreement with the conclusion of the CIT(A) in holding that TNMM is the correct method applied by the TPO for determining the arm’s length price in respect of the raw materials acquired by the assessee from its sister concerns in Korea. The CIT(A)’s findings and observations are very much relevant, and, hence, they are being reproduced here as under:—

"8.3 TNMM v. Unspecified Method as MAM.—I have carefully considered the submissions made by the appellant and all other evidences brought on record on this issue. The selection of the MAM is a question of relative merit and is also highly fact-intensive. This observation finds approval in Aztec ruling as well. It would be appropriate to start analyzing this issue by listing out the essence of the Aztec Ruling in respect of MAM. The observations made by the Hon’ble Special Bench of ITAT are summarized below:—

(i )The burden to select the most appropriate method is on the assessee.

(ii )The selection of the MAM by the assessee is, however, to be done objectively, after considering all the facts and circumstances of the case, availability of reliable data and degree of comparability.

(iii)Selection of MAM should be based on analysis of functions performed, asset deployed and risks assumed (FAR analysis) of both the controlled and uncontrolled transactions.

(iv)For rejecting the method followed by the assessee and to substitute the same by a new method, the burden of proof shifts to the TPO/Assessing Officer and the TPO/Assessing Officer has to provide cogent reasons for the substitution.

(v )Appropriate and suitable adjustment in the arm’s length price determined by the taxpayer can be made by the Assessing Officer on the basis of information furnished by the assessee or otherwise available with revenue authorities. However, any changes in the most appropriate method for computing the arm’s length price is to be dealt with by way of speaking order.

(vi)Computation of arm’s length price is essentially a factual exercise. Each case depends on its own peculiar facts and circumstances. If identical transactions is not found for comparison, suitable adjustment is to be made to the price of somewhat similar transaction.

8.3-1 It has been observed in the (1995) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("OECD Guidelines") that TNMM may afford a practical solution to otherwise insoluble transfer pricing problems, especially when there is sufficient data on uncontrolled transaction. Therefore, TNMM is recognized as a method of last resort that assists in determining whether transfer pricing complies with the arm’s length principles or not. No such preference in favour of particular set of methods is found in the TP regulations in India. Consequently, the final selection of a method as the MAM is to be decided purely on facts and circumstances of a case and availability of reliable data. The Aztec ruling also precisely records a similar finding.

8.3-2 In the case, the appellant itself had chosen TNMM as the MAM for the international transaction relating to purchase of raw-materials from the A.E. as evident from annexed Statement-1 of that report. The TNMM was accepted as the MAM after rejecting all other specified methods under the TP regulations in India. The relevant portion of the TP report is reproduced below:—

‘The following methods were rejected based on the above factors (reproduced in Para 4.6 of this order) :

uThe Comparable Uncontrolled Price Method was rejected on the basis of no comparable transaction being carried out by the Indian entity with a third party.

uThe Resale Price method was rejected on the grounds of II Jin Korea not having sold similar items to any unrelated enterprise for this method to be applied.

uThe Cost Plus method was rejected as no information on direct or indirect costs being available from the associated enterprise.

uThe Profit Split Method was rejected as its applicability is for transactions which are in no way similar to the transactions in question.

By the process of elimination the Transactional Net Margin Method (TNMM) has been used to determine the Arm’s Length Price of each transaction’.

The TPO has simply concurred with the selection of the appellant under the given circumstances.Under these circumstances, there is no justification for the appellant to come up with the argument that TNMM was used in the TP report only for providing a general view of the industry for comparison without bringing on record any additional evidence to support its contention.

8.3-3 Another contention of the appellant related to the choice of the MAM is the fact that it had outsourced a substantial part of its procurement of raw materials to its A.E. at Korea and offered a reasonable margin of 8.27 per cent as compensation for this function. Prices paid to third party vendors by the A.E. and selling these very items at cost or below the cost or a nominal margin of profit to the appellant, by themselves, provide sufficient evidence of fulfilment of arm’s length standards. It has been argued by the appellant that in the presence of such clinching direct evidence, there is no justification for adopting TNMM as the MAM.

8.3-4 I find a basic flaw in the arguments put forward by the appellant. In essence, the appellant is talking about a benchmarking analysis, with the Korean A.E. as the tested party, looking at the reasonableness of the rate of compensation paid by the appellant. Such a benchmarking analysis could have been done by the appellant by examining either the Resale Price Method or the Cost Plus Method, with Korean A.E. as the tested party and conducting the comparability analysis by selecting a set of comparables operating in the Korean market performing similar functions, assuming similar risks and deploying similar assets as that of the A.E. However, the appellant had not opted for such a analysis and conducted the benchmarking analysis with the appellant as a tested party and companies operating in the Indian market as comparables. Under these circumstances, I do not find any merit in the appellant’s argument that 8.27 per cent compensation paid to the Korean A.E. represents arm’s length price for the appellant’s transactions as no comparability analysis has been conducted from that prospective under the specified TP regulations.

8.3-5 In view of the foregoing analysis, I am of the considered view that under the given circumstances, TNMM is the MAM and the TPO by accepting the appellant’s own methodology has not committed any legal infirmity. The argument for using an analysis by taking the Korean A.E. as the tested party is also not acceptable as it is not substantiated by any real comparability analysis."

14. In the course of hearing of this appeal, the ld. counsel for the assessee also pointed out that the TPO has failed to make adjustments to the net profit margin determined by him on account of benefit accruing to the assessee for utilizing the fund in as much the assessee’s associate enterprise was supplying raw materials to the assessee on credit for which the associate enterprise was not charging any interest, and if adjustment is made on account of this benefit of purchasing raw material on credit, the adjustment made by the TPO would be wiped out and, consequently, no addition would be called for. In this respect, it is important to point out that only customer purchasing printed circuit board from the assessee is LG Electronics, and its subsidiaries in Korea and Thailand are the principal purchaser of assessee’s associate concerns situated in Korea. The assessee has been supplying manufactured items to LG Electronics, the only customer of the assessee, which has a close association and business dealing with assessee’s concerns in Korea. The present assessee-company is established in India with a view to supply the same item of printed circuit boards in India, which are also being supplied by its associate concerns in Korea and Thailand to LG Electronics. Keeping all these facts in mind, a query was raised by the Bench in the course of hearing this appeal to show as to whether the assessee has been realizing the sale price from the LG Electronics Ltd., India much before the payment made by the assessee to its associate concerns on account of the cost of raw materials purchased by the assessee, and thereby whether the assessee was getting any benefit of utilization of the fund realized from LG Electronics of India to earn some other income instead of making the payment to its associate concern in Korea. In this respect, the ld. counsel of the assessee expressed his inability to furnish the details about when and how the assessee has been realizing the sale proceeds from the LG Electronics and as and when the payments are being made by the assessee to his associate in Korea. Therefore, in the absence of details in this respect, the assessee’s contention that some adjustment is to be made to the net margin determined by the TPO on account of benefit accruing to the assessee by way of interest on the amount payable by the assessee to its associate concerns is rejected.

15. The assessee has also taken one alternative ground out of the total raw materials consumed by the assessee for manufacturing print circuit boards, only 45.51 per cent of the total raw materials were imported through assessee’s associate concerns, and, therefore, any adjustment, if any called for, can only be made to the 45.51 per cent of the total turnover, and not to the total turnover of the assessee. After considering the facts of the case, we do not find any difficulty in accepting this contention of the assessee that at best only 45.51 per cent of the operating profit can be attributed to imported raw material acquired from assessee’s associate concerns. In the present case, the Assessing Officer has calculated the operating profit on the entire sales of the assessee, which in our considered opinion, is not justified, when it is admitted position that only 45.51 per cent of raw material has been acquired by the assessee from its associate concerns for the purpose of manufacturing items. The assessee has stated that the operating profit if applied to 45.51 per cent of the turnover would come to Rs. 35,52,573 as against operating profit of Rs. 24,35,175 booked by the assessee, and the difference thereof would only be called for to be made as addition to the profit shown by the assessee. We, therefore, direct the Assessing Officer to modify the assessment and make the adjustment only to the extent of difference in the arm’s length operating profit with adjusted profit with reference to the 45.51 per cent of the turnover, and not to the total turnover of the assessee. Therefore, to this extent, the addition made by the Assessing Officer and further confirmed by the CIT(A) is reduced. We order accordingly.

16. In the result, the appeal filed by the assessee is partly allowed in the manner as indicated above.