TP Adjustment Quashed: Controlled Transaction Cannot Serve as ALP Benchmark for Another Controlled Transaction – ITAT Delhi Rules in Honda Trading Case

Introduction

The Income Tax Appellate Tribunal, Delhi Bench, has delivered a significant verdict reinforcing fundamental transfer pricing principles in the matter concerning Honda Trading Corporation India Pvt. Ltd. The Tribunal struck down a transfer pricing adjustment of ₹2.57 crore that was imposed on commission payments, emphasizing that one controlled transaction cannot serve as the arm's length price benchmark for evaluating another controlled transaction. This landmark decision reaffirms that arbitrary pro-rata adjustments have no legal foundation within the framework of Chapter X of the Income Tax Act, 1961.

The adjudication addressed Assessment Year 2021-22 and dealt with critical procedural and substantive issues in transfer pricing assessments. While a substantial trading segment adjustment of ₹11.58 crore had already been rectified to NIL under Section 154, the focal point of this appeal centered on the commission adjustment methodology adopted by the Transfer Pricing Officer (TPO) following vague directions from the Dispute Resolution Panel (DRP).

Factual Matrix of the Case

Background of the Assessee

Honda Trading Corporation India Pvt. Ltd. (the assessee entity) submitted its return of income for Assessment Year 2021-22 on 10th February 2022, declaring total income of ₹9.78 crore. The assessee company's primary business operations comprised trading in steel automotive parts, automotive coils, and equipment. Additionally, the entity provided business auxiliary services to its parent company and other group entities, generating service income and commission revenue. These trading and service operations spanned both domestic Indian markets and international territories.

Scrutiny Assessment Proceedings

The case was selected for comprehensive scrutiny through the Computer Assisted Scrutiny Selection (CASS) mechanism. Notice under Section 143(2) was duly issued on 28th June 2022 by the National Faceless Assessment Centre. The assessee responded promptly on 12th July 2022, submitting all requisite documentation including computation of income, ITR copy, Form 3CB & 3CD for Assessment Year 2021-22, Form 3CEB, and detailed Balance Sheet with schedules.

Transfer Pricing Reference

Given that transfer pricing risk parameters formed part of the scrutiny selection criteria, the Assessing Officer referred the matter to the Transfer Pricing Officer on 2nd August 2022 for detailed examination of international transactions.

International Transactions Under Examination

The TPO's examination revealed the following controlled transactions:

• Import of parts and products for resale: ₹504.08 crore
• Export of parts and products: ₹176.83 crore
• Commission received from AE: ₹2.96 crore (0.59% of imports)
• Commission paid to AE: ₹3.62 crore (2.05% of exports)

Transfer Pricing Officer's Initial Adjustment

The TPO initially proposed an adjustment of ₹12.49 crore pertaining to the trading segment through order under Section 92CA(3) dated 31st October 2023. This figure was subsequently revised to ₹11.58 crore vide order dated 14th October 2024 while implementing the directions issued by the DRP under Section 144C dated 25th September 2024.

However, this substantial trading segment adjustment of ₹11.58 crore was subsequently reduced to NIL through a rectification order under Section 154 dated 26th December 2024. The rectification order acknowledged that the assessee's operating margin of 1.65% on revenue from trading activity fell comfortably within the arm's length range (35th percentile – 1.41% and 65th percentile – 3.82%) as calculated per the order dated 14th October 2024. Consequently, no adjustment was warranted regarding the trading activity.

Dispute Resolution Panel's Directions

Vague Verification Mandate

The DRP, through its directions under Section 144C dated 25th September 2024, made certain observations in paragraphs 4 and 5 regarding the disparity between commission received and commission paid. The DRP noted that commission received amounted to approximately ₹2.95 crore on purchases of ₹504 crore, whereas commission paid amounted to approximately ₹3.62 crore on exports of about ₹176 crore. The Panel observed that commission paid represented a substantially higher percentage compared to commission received.

Based on this observation, the DRP directed the TPO "to verify this aspect of the transaction also without making further enquiries with assessee" in view of Section 144C(13), which mandates completion of assessment without providing further opportunity of hearing.

Legal Position on DRP Powers

This direction proved contentious as Section 144C(8) explicitly provides that the Dispute Resolution Panel may confirm, reduce, or enhance variations proposed in the draft order. However, it categorically prohibits the Panel from setting aside any proposed variation or issuing directions for further enquiry and passing of assessment order.

TPO's Adjustment Following DRP Directions

Pro-Rata Methodology Adopted

Acting upon the DRP's direction, the TPO undertook a comparative analysis of commission received versus commission paid. The TPO observed that commission paid (2.05%) represented a substantially higher percentage compared to commission received (0.59%).

Computation of Adjustment

Following a pro-rata basis calculation, the TPO made an adjustment for the differential (excess) amount of commission paid in comparison to commission received:

This adjustment of ₹2.57 crore formed the basis of the present controversy before the Tribunal.

Assessee's Contentions Before ITAT

Procedural Violations

The assessee raised multiple substantive and procedural objections to the impugned adjustment:

Violation of Natural Justice: The adjustment of ₹2.57 crore was made by the TPO without providing any opportunity of being heard to the assessee. This adjustment did not form part of the draft assessment order under Section 144C and was introduced only in the order giving effect dated 14th October 2024.

Unclear DRP Directions: The directions issued by the DRP for verifying commission transactions lacked necessary clarity and context, leading the TPO to arrive at irrational conclusions and make the contested adjustment.

Economic Double Taxation: The transactions pertaining to commission received and paid were already included within the total international transaction value utilized for calculating the trading segment adjustment, potentially resulting in double taxation.

Substantive Legal Arguments

Fundamental Transfer Pricing Principle Violated: The assessee contended that the TPO's action of making the adjustment disregarded fundamental principles of transfer pricing by inappropriately comparing two controlled transactions – commission paid and commission received by the assessee with its Associated Enterprises.

Definition of Arm's Length Price: The assessee emphasized that Section 92F(ii) of the Act defines "arm's length price" to mean "a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions."

Therefore, for a price to be treated as ALP, it must be derived from transactions:

• Entered into between persons other than AEs, and
• Conducted in uncontrolled conditions

Commission Received Cannot Be ALP: The commission received by the assessee from its AE cannot constitute the arm's length price for benchmarking commission paid, as such commission received is:

• Neither entered into between persons other than AEs
• Nor concluded in uncontrolled conditions