Tribunal directs using PBDIT for ALP, emphasizes depreciation adjustments over repair expenses.

The Tribunal allowed the appeal, directing the AO to use PBDIT as the profit level indicator for determining the ALP of international transactions. It emphasized the need for adjustments in depreciation and rejected the CIT (A)'s reasoning equating depreciation with repair and maintenance expenses. The order was pronounced on 24/03/2021 at Ahmedabad.

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Issues Involved:
1. Determination of the most appropriate method (MAM) for calculating the arm's length price (ALP).
2. Treatment of rental income in computing operating profit.
3. Selection of profit level indicator (PBIT vs. PBDIT) for determining ALP.
4. Comparability of selected companies for transfer pricing purposes.

Detailed Analysis:

1. Determination of the Most Appropriate Method (MAM) for Calculating ALP:
The assessee used the Cost Plus Method (CPM) and Comparable Uncontrolled Price (CUP) method to determine the ALP for its international transactions. The Assessing Officer (AO) rejected these methods and adopted the Transactional Net Margin Method (TNMM) as the MAM. The AO selected three comparables and calculated the arithmetic mean of their operating margins at 9.80%, whereas the assessee's margin was 1.40%. The CIT (A) upheld the AO's selection of TNMM, noting that the assessee did not provide comparables to support its methods (CPM and CUP) and only conducted a search using the TNMM method after the AO’s show cause notice.

2. Treatment of Rental Income in Computing Operating Profit:
The CIT (A) addressed the issue of rental income, which the AO had excluded from operating income. The CIT (A) agreed with the assessee's contention that if rental income is excluded, related expenses should also be excluded. However, the CIT (A) ultimately decided that rental income should be treated as part of the operating income to automatically account for related expenses, directing the AO to adjust the operating profit accordingly.

3. Selection of Profit Level Indicator (PBIT vs. PBDIT) for Determining ALP:
The assessee argued that due to higher depreciation costs compared to comparables, the Profit Before Depreciation, Interest, and Taxes (PBDIT) should be used as the profit level indicator instead of Profit Before Interest and Taxes (PBIT). The CIT (A) rejected this, reasoning that higher depreciation in new entities is offset by higher repair and maintenance costs in older entities. The Tribunal, however, found that depreciation and repair/maintenance are independent expenses and cannot be equated. The Tribunal ruled in favor of the assessee, directing the AO to use PBDIT as the profit level indicator.

4. Comparability of Selected Companies for Transfer Pricing Purposes:
The assessee contended that the turnover of selected comparables was significantly higher than its own, suggesting that companies with similar turnover should be used. The Tribunal did not find it necessary to adjudicate this issue separately, as it had already ruled in favor of using PBDIT, rendering this contention moot.

Conclusion:
The Tribunal allowed the appeal filed by the assessee, directing the AO to use PBDIT as the profit level indicator for determining the ALP of the international transactions. The Tribunal emphasized the need for adjustments in depreciation and rejected the CIT (A)'s reasoning equating depreciation with repair and maintenance expenses. The appeal was allowed, and the order was pronounced on 24/03/2021 at Ahmedabad.

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