Appeal success: Fresh adjustments on segmental accounts needed for accurate arm's length price calculation

The appeal was allowed, directing the Assessing Officer/Transfer Pricing Officer to consider audited segmental accounts, exclude non-comparable companies, and make fresh adjustments. The Tribunal highlighted the importance of accurately computing the arm's length price by taking into account business decline and cost structure. The order was issued on 4th October 2022.

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Issues Involved:
1. Jurisdictional error in reference to Transfer Pricing Officer (TPO).
2. Addition to returned income by re-computing arm's length price.
3. Violation of natural justice principles.
4. Rejection of segmental allocation between AE and Non-AE segments.
5. Basis for calculation of proportionate transfer pricing adjustment.
6. Acceptance of non-comparable companies.

Detailed Analysis:

Jurisdictional Error in Reference to TPO
The assessee contended that the Assessing Officer (AO) did not record any reasons in the assessment order to justify the reference to the TPO for computing the arm's length price, as required under section 92CA(1) of the Income Tax Act. However, this ground was not pressed with substantial arguments during the hearing.

Addition to Returned Income by Re-computing Arm's Length Price
The AO, based on the TPO's adjustments, enhanced the income of the assessee by Rs. 3,26,67,008. The TPO rejected the segmental determination of AE and Non-AE profits, applied new quantitative filters, and introduced additional comparable companies, leading to the re-computation of the arm's length price.

Violation of Natural Justice Principles
The assessee argued that the principles of natural justice were violated as the DRP directions were not served despite several requests, and no opportunity of being heard was given before enhancing the transfer pricing adjustment. This ground was also not pressed with substantial arguments during the hearing.

Rejection of Segmental Allocation Between AE and Non-AE Segments
The TPO rejected the segmental accounts provided by the assessee, stating that the AE transactions constituted more than 98% of the operating revenue, and the expenses were allocated based on entire income rather than operating income. The DRP upheld this view, agreeing with the TPO's findings. However, the Tribunal found that the tax authorities failed to consider the significant decline in non-AE business and the unchanged employee costs, leading to erroneous adjustments. The Tribunal directed the AO/TPO to consider the audited segmental accounts and make fresh adjustments.

Basis for Calculation of Proportionate Transfer Pricing Adjustment
The assessee argued that the revenue should not be the basis for calculating proportionate adjustments, as significant costs were incurred despite the decline in non-AE revenue. The Tribunal agreed, noting that the tax authorities should have considered the segmental level profitability. The AO/TPO was directed to make fresh adjustments based on audited segmental accounts.

Acceptance of Non-Comparable Companies
The Tribunal observed that the companies selected by the TPO and upheld by the DRP were not functionally comparable to the assessee, which deals exclusively in wastewater treatment facilities. Companies with diversified business interests and nominal involvement in wastewater treatment were included as comparables. The Tribunal directed the AO/TPO to exclude Mitcon Consultancy & Engineering Services Ltd., Aakar Abhinav Consultants Pvt. Ltd., Feedback Infra Pvt. Ltd., and Mahindra Consulting Engineers Limited from the comparables and make fresh adjustments.

Conclusion:
The appeal of the assessee was allowed with directions to the AO/TPO to consider the audited segmental accounts and exclude non-comparable companies, leading to fresh adjustments. The Tribunal emphasized the need for a realistic view of the business decline and cost structure, ensuring that the arm's length price is computed accurately. The order was pronounced in the open court on 4th October 2022.

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