2025 (4) TMI 30 - AT - Income Tax

TPO's business segmentation into Manufacturing and Trading upheld for transfer pricing benchmarking with TNMM application confirmed

ITAT DELHI upheld TPO's segmentation of assessee's business into Manufacturing and Trading for transfer pricing benchmarking, following coordinate bench ... Addition on account of ALP adjustment - segmentation of the assessee's business into Manufacturing and Trading for benchmarking purposes - TPO considered assessee as the tested party and applied TNMM for bench marking both segments separately - HELD THAT:- We are of the considered view that the assessee is indulged in two types of business activities. Firstly, the pure trading and secondly Trading after processing the goods as per specification/tailor-made. The coordinate bench in the assessee’s own case [2021 (11) TMI 1217 - ITAT DELHI] has upheld the segmental analysis in principle. Respectfully following the reasoning we do not find any infirmity into the segmentation; Manufacturing and Trading done by the TPO for benchmarking purposes. Applicability of TNMM instead of Cost-Plus Method - We have taken note of the fact that the assessee itself has applied TNMM in AYs 2012-13, 2013-14 and 2014-15 in its 3CEB Forms and Revenue has accepted the same. No infirmity in impugned orders upholding TNMM in these years. Hence the applicability of TNMM instead of Cost-Plus Method is upheld in both years. Further, in view of the TPO’s orders of AYs 2012-13, 2013-14 and 2014-15, we upheld the finding of lower authorities in treating assessee as a tested party in both years. Selection of comparables - We without going into the merit and demerit of comparables, direct the TPO to take comparables from the baskets of comparables of these years for benchmarking purposes only. The undisputed comparables of these years; AYs 2012-13, 2013-14 and 2014-15, which have been finally selected for benchmarking purposes in the TP study of the assessee or by the TPO have to be taken as comparables for the present cases; AY 2009-10 and 2010-11. However, financial data of these comparables of AY 2009-10 and 2010-11 available in public domain have to be taken for respective years separately. The comparables have to be taken and done for two segments; Manufacturing and Trading, separately. We are restoring this limited issue to the TPO for working of quantum of adjustments to be made in view of the above. Broad principles accepted by the TPO in AYs 2012-13, 2013-14 and 2014-15 have to be taken for the cases in hand; AY 2009-10 and 2010-11. Disallowance of capacity utilization on the reasoning that the assessee has failed to provide requisite data - AO is directed to allow the consequential relief on this score (capacity utilization) after proper verification. For this purpose, this matter of AY 2009-10 is restored back to the TPO. Needless to say that the assessee should cooperate and make available all details required by the TPO. Exclusion of custom duty from operating margin - HELD THAT:-No doubt, a higher import content of raw material by itself does not warrant an adjustment in operating margins, as was held in the Sony India Pvt. Ltd. case, but what is to be really seen is whether this high import content was necessitated by the extraordinary circumstances beyond assessee's control. In case the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the open market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect. In case the import is part of the business model, then the higher import duty is considered to be passed on to the customers or it must be adjusted for in negotiating the purchasing price. The adjustments then are required to be made for functionally differences. The other way of looking at the present situation is to accept that business model of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments are thus required either way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison possible. The assessee cannot be expected to get the details and particulars which are not in public domain. In such a situation, i.e. when information available in public domain is not sufficient to make these comparisons possible, it is inevitable that some approximations are to be made and reasonable assumptions are to be made. None of these arguments were before any of the authorities below. What was argued before the TPO was mere fact of higher costs on account of higher import duty. We, therefore, deem it fit and proper to remit this matter to the file of the TPO for fresh adjudication. Whether foreign exchange gain/loss arising from international transactions was to be considered as an item of operating revenue profit/loss? - As in order to compute the operating margin of the taxpayer, foreign exchange gain is to be considered as part of operating income for computing the operating margin of taxpayer as well as comparables. Thus, we do not find any infirmity in the order of the Ld. CIT(A) on this issue; foreign exchange gain/loss arising from international as operating revenue profit or loss. Accordingly, the grounds relevant to this issue raised by the Revenue stand dismissed in both years. Working Capital Adjustment - This issue has been decided in favour of the assessee in its own case. Respectfully, following the said decision we decide this issue against the Revenue. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in the judgment include:1. Whether the Transfer Pricing Officer (TPO) was justified in making Arm's Length Price (ALP) adjustments by treating the assessee as the tested party instead of its foreign Associated Enterprises (AEs).2. Whether the segmentation of the assessee's business into Manufacturing and Trading for benchmarking purposes was appropriate.3. The appropriateness of applying the Transactional Net Margin Method (TNMM) instead of the Cost-Plus Method for benchmarking the international transactions.4. The correctness of the inclusion and exclusion of comparables used for benchmarking the transactions.5. Whether custom duty should be excluded from the operating margin for determining ALP.6. Whether foreign exchange gain/loss should be considered as operating profit/loss.7. Appropriateness of allowing working capital adjustment.8. The initiation of penalty under section 271(1)(c) of the Income Tax Act.ISSUE-WISE DETAILED ANALYSIS1. ALP Adjustments and Tested Party SelectionThe TPO selected the assessee as the tested party based on the OECD guidelines, emphasizing that the least complex entity should be the tested party. The assessee, primarily acting as a distributor, did not own any intangible assets or assume significant risks. The TPO applied TNMM for benchmarking, which led to adjustments in the assessee's income for both assessment years.The Court upheld the TPO's decision to treat the assessee as the tested party, noting that the assessee itself had applied TNMM in subsequent years, which the Revenue accepted. The Court found no infirmity in the TPO's approach and upheld the use of TNMM over the Cost-Plus Method.2. Segmentation of Business ActivitiesThe assessee's business was segmented into Manufacturing and Trading for benchmarking. The Court noted that the assessee was involved in both pure trading and processing activities, which justified the segmentation. The Court followed the reasoning from a previous decision in the assessee's own case, affirming the segmentation for benchmarking purposes.3. Inclusion and Exclusion of ComparablesThe dispute involved the inclusion and exclusion of certain comparables for benchmarking. The Court directed the TPO to use comparables from the subsequent years (2012-13, 2013-14, and 2014-15) for benchmarking purposes, ensuring consistency with the accepted comparables in those years.4. Exclusion of Custom Duty from Operating MarginThe assessee argued for the exclusion of custom duty from the operating margin, as it incurred significant custom duty charges compared to comparables. The Court agreed that adjustments should be made if custom duty adversely affected the operating margin. The matter was remitted to the TPO for fresh adjudication, with directions to examine the impact of custom duty on the operating margin.5. Foreign Exchange Gain/Loss as Operating Profit/LossThe Court considered whether foreign exchange gain/loss should be treated as operating profit/loss. The Court referred to previous decisions, noting that foreign exchange gain/loss related to business transactions should be considered as part of operating income. The Court upheld the CIT(A)'s decision to include foreign exchange gain/loss as operating revenue.6. Working Capital AdjustmentThe assessee sought working capital adjustment, which the CIT(A) allowed. The Court followed a previous decision in the assessee's case, finding no infirmity in the CIT(A)'s order and upholding the working capital adjustment.7. Initiation of Penalty under Section 271(1)(c)The issue of penalty initiation was deemed premature and dismissed by the Court.SIGNIFICANT HOLDINGSThe Court made several significant determinations:- The selection of the assessee as the tested party and the use of TNMM for benchmarking were upheld.- Segmentation of business activities into Manufacturing and Trading for benchmarking was justified.- The TPO was directed to use comparables from subsequent years for consistency in benchmarking.- Adjustments for custom duty were permissible if they materially affected the operating margin.- Foreign exchange gain/loss should be considered as operating profit/loss.- Working capital adjustment was upheld as appropriate.The Court's decision reflects a nuanced understanding of transfer pricing principles, emphasizing consistency in benchmarking practices and recognizing the impact of specific financial factors on operating margins.