ITAT rejects both assessee's and TPO's transfer pricing methods, remands for fresh determination using TNNM with external comparables

The ITAT Hyderabad ruled on transfer pricing adjustments for raw material transfers between Non-SEZ and SEZ units. Both the assessee's methodology excluding 70% of products and the TPO's cherry-picking approach from 11 product families were rejected as inappropriate. The matter was remanded to TPO/AO to determine arm's length price using TNNM method with external/international comparables, allowing 3% tolerance range. The tribunal allowed weighted deduction under section 35(2AB) for entire R&D expenditure including clinical trials, following consistency with previous year's order. Additional depreciation claim was allowed as the AO failed to implement DRP directions without justification. Appeal was partly allowed.

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ISSUES PRESENTED and CONSIDERED

The core legal issues considered in this judgment include:

• Whether the Transfer Pricing (TP) adjustments made by the Transfer Pricing Officer (TPO) regarding specified domestic transactions between SEZ and non-SEZ units were justified.
• Whether the disallowance of weighted deduction under Section 35(2AB) of the Income Tax Act for expenditure on clinical trials conducted outside approved facilities was appropriate.
• Whether the disallowance of additional depreciation under Section 32(iia) was justified despite the directions of the Dispute Resolution Panel (DRP).

ISSUE-WISE DETAILED ANALYSIS

Transfer Pricing Adjustments

The legal framework for this issue is governed by Section 92CA of the Income Tax Act, which mandates the determination of the Arm's Length Price (ALP) for specified domestic transactions. The TPO rejected the methodology used by the assessee, which applied the cost-plus method and a range concept for benchmarking transactions between SEZ and non-SEZ units.

The Court noted that the TPO adopted a selective approach by cherry-picking certain products from the assessee's portfolio, which was not justified. The assessee's methodology, which excluded 70% of products, was also found to be flawed. The Tribunal emphasized that the entire product range should be considered as a basket for determining the ALP.

The Court observed that for the subsequent assessment year, the TPO accepted the Transactional Net Margin Method (TNNM) as the most appropriate method. Therefore, the Tribunal remanded the issue back to the TPO/Assessing Officer to determine the ALP using TNNM based on external comparables, ensuring the operating margin falls within the 3% tolerance range.

Disallowance of Weighted Deduction under Section 35(2AB)

The legal framework involves Section 35(2AB) of the Income Tax Act, which allows weighted deductions for R&D expenditures. The Assessing Officer restricted the deduction to in-house R&D expenses, excluding clinical trials conducted outside approved facilities.

The Tribunal referenced previous decisions, including those of the Gujarat High Court, which recognized that clinical trials often occur outside approved facilities and should qualify for deductions. The Tribunal emphasized consistency with its earlier rulings and allowed the deduction for clinical trial expenses, aligning with the principle that such trials are integral to R&D activities.

Disallowance of Additional Depreciation

The issue pertains to Section 32(iia) of the Income Tax Act, which provides for additional depreciation on new plant and machinery. The DRP directed the Assessing Officer to allow this depreciation, but the Assessing Officer failed to comply.

The Tribunal criticized the Assessing Officer's non-compliance with the DRP's directions, emphasizing the importance of adhering to procedural discipline. The Tribunal directed the Assessing Officer to implement the DRP's decision, allowing the additional depreciation as claimed by the assessee.

SIGNIFICANT HOLDINGS

The Tribunal held that the TPO's selective approach in determining the ALP was inappropriate and remanded the matter for reconsideration using the TNNM method. It reiterated the importance of considering the entire product range as a basket for TP analysis.

The Tribunal upheld the assessee's claim for weighted deductions under Section 35(2AB) for clinical trials conducted outside approved facilities, aligning with judicial precedents that recognize the necessity of such trials in R&D processes.

The Tribunal directed the Assessing Officer to comply with the DRP's instructions regarding additional depreciation, highlighting the need for procedural adherence and consistency in tax assessments.

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