TP Update: Mumbai ITAT lays down rules for functional comparability

Petro Araldite P Ltd v DCIT (IT APPEAL NO. 6217 (MUM.) OF 2012 dtd 18.1.2013) Mumbai ITAT


Assessee is a concern engaged in the manufacture of `Specialty Chemicals’. Its main product is Epoxy Resins. The chemicals manufactured by it are used in the industries operating in Paints, Civil engineering applications, Structural composites, Electrical insulation material, Adhesive and Tooling material. The assessee followed Transactional Net Margin Method (TNMM) to benchmark its international transactions in a composite way for all such transactions taken together. It adopted Profit Level Indicator (PLI) as Operating Profit / Sales which was shown at 4.20%.

The assessee selected the following four comparable cases to benchmark its international transactions:

– Dai- Ichi Karkaria Ltd.
– Sunshield Chemicals Limited.
– Indo-Nippon Chemicals Company Ltd.
– Resinova Chemie Limited.

The TPO did not find any of the cases selected by the assessee as comparable but finally shortlisted the following four cases for benchmarking:

– Atul Ltd.
– IG Petrochemicals Ltd.
– Micro Inks Ltd.
– Pidilite Industries Ltd.

The assessee is aggrieved against the exclusion of two cases out of the list of four comparable cases given by it, namely, Dai- Ichi Karkaria Ltd. & Sunshield Chemicals Limited. Secondly, it is also not happy with the inclusion of two cases by the TPO, namely, Micro Inks Ltd. & Pidilite Industries Ltd.

Further, the TPO also made transfer pricing adjustment on the entity level without restricting it to the transactions with the Associated Enterprises.

Assessee’s contentions:

  • DIKL manufactures specialty chemicals used for imparting lubrication and antistatic properties to textile filaments and yarns.
  • The overall segment in which the assessee and DIKL are engaged in, is similar.
  • Both assessee and DIKL are dealing with specialty chemicals industry and hence no distinction could have been justifiably made.
  • With regard to inclusion of Pidilite, the assessee contended that the extraordinary cases involving acquisitions, mergers or de-merger during the relevant period lose the tag of comparability.

Tax Authority’s contentions:

  • Three of the products, namely, Trimetazidine, Tramadolc and Carboprost were functionally different.
  • In view of such functional differences, TPO ordered the exclusion of this case from the assessee’s list of comparables.


  • The chemicals manufactured by both the assessee and DIKL cater to the needs of altogether different types of industries.
  • Following tests are laid down in order to select comparables:
    The first and the foremost factor of relevance is the functional comparability.
    Once functional profile of two cases is found to be similar, then comes the question of examining the assets employed and risks undertaken by such functionally comparable cases.
    If the other case is functionally incomparable, that goes out of the reckoning at the very threshold.
    A case is said to be functionally comparable if it is in the same activity of business. If the activity of such case is by and large similar to the assessee’s case with some minor exceptions here and there, then also we can include such a case in the list of comparables provided the incomparable part of the functional profile of the other case is not such so as to have damaging influence over its overall profit rate.
    But if the other case is largely different in the functional profile, but comparable part is minimal, such case can not be considered as comparable.
    It is no doubt true that the TNMM is tolerant to functional differences between two cases to some extent, but at the same time the broader functional dissimilarities cannot be overlooked in selecting comparables.
  • Further, Rule 10B(1)(e)(ii) provides that ‘the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base. Section 92C(2) provides that : ‘The most appropriate method referred to in sub-section (1) shall be applied for determination of arm’s length price, in the manner as may be prescribed’. First proviso to this provision provides : ‘that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices’. These provisions make it amply manifest that the attempt should be to first find out a really comparable case and then in the alternative the endeavour should be to find out more than one comparable uncontrolled case, if these are available. There is no warrant in the relevant provisions that one must choose more than one case for benchmarking, even at the cost of comparability.
  • If the number of comparable cases is more than one, then it is advisable to pick all such cases so as to iron out the peculiarities of a particular case. But when the number of comparable cases is limited to one or more, then no futile attempt should be made to find out even some incomparable cases with a view to swell the list of comparables and ultimately distort the profit rate of the really comparable case(s). The crux of the matter is that the comparability cannot be sacrificed at any cost at any stage.
  • With regard to the comparable of Pidilite, ITAT relied on Hyderabad Bench of Tribunal in the case of Capital IQ Information Systems (India) (P.) Ltd. v. Dy. CIT [ITA No.6961/Hyd/2011 wherein it was held that a company cannot be considered as a comparable because of exceptional final results due to mergers/de-mergers. 
  • With regard to the entity-wide application of transfer pricing provisions, ITAT held that the provisions divulges that the transfer pricing adjustment is required to be made only in respect of transactions between the AEs.

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