2024 (12) TMI 1615 - AT - Income Tax

TPO Must Include Bad Debts in Operating Expenses for PLI Under Section 144C(10) Guidance

Hitachi Energy Technology Services Pvt. Ltd., (formerly ABB Power Technology Services Pvt. Ltd.) Versus The Deputy Commissioner of Income Tax, Circle 3 (1) (1), Bengaluru.

Hitachi Energy Technology Services Pvt. Ltd., (formerly ABB Power Technology Services Pvt. Ltd.) Versus The Deputy Commissioner of Income Tax, Circle 3 ... ISSUES: Whether the transfer pricing adjustment made under section 92C(3) of the Income Tax Act, 1961, in respect of international transactions for provision of engineering design services, was justified.Whether the learned Assessing Officer (AO), Transfer Pricing Officer (TPO), and Dispute Resolution Panel (DRP) erred in rejecting the assessee's economic analysis and benchmarking study for determination of the arm's length price (ALP).Whether the filters and comparable companies selected by the TPO and DRP for transfer pricing analysis were appropriate and correctly applied.Whether bad debts written off by a comparable company should be treated as operating expenditure or as an unascertained liability in computing operating margin for transfer pricing purposes.Whether directions issued by the Dispute Resolution Panel under section 144C(10) of the Act are binding on the Assessing Officer/TPO.Whether suitable adjustments should be made to account for differences in working capital and risk profile between the assessee and comparable companies. RULINGS / HOLDINGS: The transfer pricing adjustment of Rs. 12,73,30,000 made by the TPO and upheld by the DRP is generally sustained except for the issue relating to the treatment of bad debts written off in the margin computation of a comparable company.The AO/TPO/DRP erred in not accepting the assessee's economic analysis and benchmarking study, but this ground was not pressed except in relation to margin computation of one comparable company.The filters applied by the TPO, including export earning filter of 75%, related party transaction filter, and turnover thresholds, were upheld except for issues relating to the margin computation of Mahindra Consulting Engineers Ltd.The treatment of bad debts written off by Mahindra Consulting Engineers Ltd. as a non-operating item or unascertained liability was incorrect; bad debts written off is an 'ascertained liability which is written off in the books of accounts' and should be treated as operating expenditure in computing the operating margin.Pursuant to section 144C(10), the directions of the Dispute Resolution Panel to compute margins as per the annual accounts are 'binding on the assessing officer,' and non-compliance constitutes violation of the provisions of the Act.The AO/TPO is directed to recompute the profit level indicator (PLI) of Mahindra Consulting Engineers Ltd. by including bad debts written off as operating expenditure and adjust the transfer pricing adjustment accordingly.Grounds relating to other comparability filters, selection or rejection of comparable companies, and adjustments for working capital and risk profile were not argued and thus dismissed. RATIONALE: The transfer pricing provisions under the Income Tax Act, 1961, particularly sections 92C(3), 143(3), 144B, and 144C, govern the determination of arm's length price for international transactions and provide for assessment and dispute resolution mechanisms.The Transfer Pricing Officer applies statutory filters to select comparable companies for benchmarking, including financial year data consistency, turnover thresholds, related party transaction limits, and export revenue criteria, to ensure reliability of comparables.The Dispute Resolution Panel's directions under section 144C(10) are mandatory and binding on the Assessing Officer, ensuring adherence to procedural fairness and correctness in transfer pricing determinations.The distinction between 'bad debts written off' and 'provision for bad and doubtful debts' is significant; the former is an actual expense recorded in statutory accounts and must be treated as operating expenditure, affecting the operating margin used in transfer pricing analysis.The court emphasized adherence to accounting standards and statutory provisions in transfer pricing computations and rejected the treatment of bad debts written off as an unascertained liability, reinforcing the principle that transfer pricing adjustments must be based on accurate and complete financial data.No doctrinal shift or dissenting opinion was recorded; the judgment partly allowed the appeal solely on the issue of margin computation for one comparable company, directing recomputation consistent with binding DRP directions.