Tribunal accepts segmental profitability computation for transfer pricing adjustments, remands comparable selection and working capital issues

ITAT Delhi allowed the appeal partially regarding TP adjustments. The tribunal rejected TPO's allocation of operating costs between AE and non-AE segments based on turnover, accepting assessee's segmental profitability computation since separate employee accounts were maintained. For comparable selection, Korus Engineering Solutions was excluded due to insufficient functional profile information, while TCE Consulting Engineers was retained despite low export turnover as no export filter was applied. Onward Technologies' exclusion for RPT exceeding 25% was remanded to AO for examination. Working capital adjustment and computational error issues were also remanded for fresh consideration with proper hearing opportunity.

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ISSUES PRESENTED and CONSIDERED

The core legal issues considered in this judgment are as follows:

• Whether the segmental profitability furnished by the assessee should be accepted, specifically regarding the allocation of operating costs between AE and non-AE segments.
• Whether certain companies included as comparables in the Transfer Pricing analysis are functionally similar to the assessee and should be retained or excluded.
• Whether the working capital adjustment raised by the assessee is justified and should be allowed.
• Whether there is a computational error in computing the operating profit margins of the comparables, as claimed by the assessee.

ISSUE-WISE DETAILED ANALYSIS

Segmental Profitability and Allocation of Operating Costs

The relevant legal framework involves the Transfer Pricing regulations under the Income-tax Act, 1961. The Tribunal considered the application of the Transactional Net Margin Method (TNMM) and the Profit Level Indicator (PLI) for benchmarking transactions with Associated Enterprises (AEs).

The Tribunal noted that the Transfer Pricing Officer (TPO) accepted TNMM as the most appropriate method but disagreed with the allocation of operating costs, specifically employee costs, between AE and non-AE segments based on turnover ratios. The assessee argued that salary expenses were separately identifiable and should not be allocated based on turnover.

The Tribunal found that the assessee maintained project-wise accounts, including details of employees and their salaries, which were specific to the AE segment. It concluded that the TPO's approach to aggregate employee costs was unjustified, as the costs were clearly identifiable. The Tribunal accepted the PLI computed by the assessee, allowing this ground.

Inclusion of Certain Comparables

The Tribunal examined the inclusion of specific companies as comparables in the Transfer Pricing analysis:

• Korus Engineering Solutions Pvt. Ltd.: The Tribunal found that the company's business profile was not sufficiently detailed in public records, making it difficult to ascertain functional similarity with the assessee. The Tribunal directed the exclusion of this company as a comparable.
• TCE Consulting Engineers Ltd.: The assessee challenged this company's inclusion due to low export sales turnover. The Tribunal noted that neither party applied an export turnover filter initially, so it upheld the inclusion of this company as a comparable.
• Onward Technologies Ltd.: The issue of Related Party Transactions (RPT) exceeding 25% was raised for the first time before the Tribunal. The Tribunal restored the issue to the Assessing Officer for examination, directing exclusion if RPT exceeded 25%.

Working Capital Adjustment

The Tribunal directed the Assessing Officer to examine the assessee's claim for working capital adjustment, considering relevant statutory provisions and judicial precedents. The Tribunal emphasized providing the assessee with a reasonable opportunity to be heard.

Computational Error in Operating Profit Margins

The Tribunal directed the Assessing Officer to review the alleged computational error in the operating profit margins of comparables, ensuring the assessee is heard before making a decision.

SIGNIFICANT HOLDINGS

The Tribunal's significant holdings include:

• The Tribunal found that the allocation of employee costs based on turnover was unjustified when such costs were separately identifiable. It stated: "We do not find any valid reason why an aggregate approach has to be adopted and the employee cost has to be apportioned between the AE and non-AE segments based on turnover."
• In excluding Korus Engineering Solutions Pvt. Ltd. as a comparable, the Tribunal emphasized the lack of detailed public information and stated: "Simply based on certain information in the website of the company functional similarity cannot be adjudged."
• The Tribunal restored the issue of RPT exceeding 25% for Onward Technologies Ltd. to the Assessing Officer, highlighting procedural fairness.

The appeal was partly allowed, with specific directions for further examination and adjustments by the Assessing Officer, ensuring compliance with statutory provisions and procedural fairness.

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