2023 (3) TMI 1564 - AT - Income Tax

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

WSP Consultants India Pvt. Ltd., Versus Deputy Commissioner Income Tax, Circle-27 (2), New Delhi

ITAT Delhi allowed the appeal partially regarding TP adjustments. The tribunal rejected TPO's allocation of operating costs between AE and non-AE segments ... TP Adjustment - computation of operating cost - rejection of segmental profitability furnished by the assessee - TPO has not accepted assessee’s claim and allocated to both the AE and non-AE segments on the basis of the turnover of the respective segments - HELD THAT:- When the employees of AE and non-AE segments are separately identifiable based on books of accounts maintained by the assessee, 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. It is evident, neither the TPO, nor learned DRP have disputed the fact that the assessee has maintained separate accounts for employee cost. Basically, DRP has rejected assessee’s claim for two reasons, firstly, on what basis the common employees were allocated is not clear and, secondly, hourly work-sheet of employees was not made available. We do not find the aforesaid reasoning of DRP acceptable. Firstly, as discussed earlier, the assessee has maintained project-wise list of employees working in AE segment. Therefore, the allegation of DRP that on what basis the common employees were allocated is not known does not seem to be borne out from record. Insofar as, the non-maintenance of hourly work-sheet of employees, we are of the view that there is no valid reason for the assessee to maintain such hourly worksheet, when it is not raising its invoices on hourly basis. We do not approve the decision of the TPO and learned DRP in allocating employees cost between the AE and non-AE segments. Therefore, the PLI computed by the assessee has to be accepted. This ground is allowed. Comparable selection - Korus Engineering Solutions Pvt. Ltd. - On perusal of the annual report of the company placed in the paper-book, it is observed that the information regarding the business profile of the company is sketchy and lacks necessary details. Further, the balance-sheet and profit and loss account do not give the break-up of the source of revenue earned. Therefore, due to lack of information regarding the functional profile of the company available in the public domain, it cannot be ascertained, whether it is functionally similar to the assessee. Simply based on certain information in the website of the company functional similarity cannot be adjudged. Therefore, for this reason, the company, in our view cannot be selected as a comparable. Insofar as the other contention of the assessee regarding substantially less export turnover compared to the assessee, we are unable to accept assessee’s claim as neither the assessee, nor TPO have applied the export turnover filter. For the reasons discussed above, we direct the AO to exclude this company as a comparable. TCE Consulting Engineers Ltd. - assessee seeks exclusion of the aforesaid company is due to substantially low export sales turnover, which works out to 6.21% of the total turnover as compared to 100% exports of the assessee - On a specific query, appearing for the assessee fairly submitted that neither the assessee has applied the export turnover filter in its TPSR, nor the TPO has applied the said filter. Therefore, in our view, at this stage, we cannot introduce a fresh filter to select/reject comparables as it will disturb the entire TP analysis of the assessee and the TPO. Therefore, we are inclined to uphold the selection of this comparable. Onward Technologies Ltd. - only ground on which the assessee seeks exclusion of this company is due to failure of Related Party Transaction (RPT) of more than 25% - Both the TPO and learned DRP have applied RPT filter of more than 25%. Therefore, any company having RPT of more than 25% has to be excluded. However, considering the fact that the assessee is raising the issue of RPT for the first time before the Tribunal, we are inclined to restore the issue to the AO for examining assessee’s claim and excluding the comparable in case RPT is found to be more than 25%. Ground is partly allowed. Working capital adjustment - We direct the AO to examine assessee’s claim, keeping in view the relevant statutory provisions and judicial precedents applicable to the assessee. Needless to mention, the assessee must be afforded reasonable opportunity of being heard to the assessee before deciding the issue. This ground is allowed for statistical purposes. Computational error in computing the operating profit margins of the comparables - As we direct the AO to examine assessee’s claim with reference to the facts and materials on record and rectify the computational error, if any, in computing the profit margin of the comparables. The assessee must be afforded reasonable opportunity of being heard before deciding the issue. ISSUES PRESENTED and CONSIDEREDThe 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 ANALYSISSegmental Profitability and Allocation of Operating CostsThe 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 ComparablesThe 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 AdjustmentThe 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 MarginsThe 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 HOLDINGSThe 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.