Assessee wins transfer pricing appeal as adjustments deleted for falling within tolerance limit despite TPO's segment audit objections

The ITAT Delhi allowed the assessee's appeal against transfer pricing adjustments made by the TPO. The TPO had rejected the assessee's TP study claiming segments were not audited, but the ITAT found this rejection was done summarily without proper justification. The tribunal noted that even accepting the TPO's profit level indicator calculation, the results fell within the +1% tolerance limit, negating any adjustment requirement. Following the Honeywell precedent, the ITAT held that filing audited segments is unnecessary when accounts are audited and figures remain undisturbed by the TPO, thereby deleting all adjustments.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal include:

- Whether the Assessing Officer (AO) had jurisdiction and authority to make a reference to the Transfer Pricing Officer (TPO) under Section 92CA(1) of the Income Tax Act, 1961;

- Whether the TPO had jurisdiction to pass the Transfer Pricing (TP) order dated 28.10.2023;

- Whether the AO erred in not issuing the final assessment order in conformity with the directions of the Dispute Resolution Panel (DRP), thereby violating mandatory provisions under Sections 144C(10) and 144C(13) of the Act;

- Whether the adjustments made by the TPO to the Arm's Length Price (ALP) of international transactions, specifically the rejection of the Internal Transactional Net Margin Method (TNMM) and substitution with an external TNMM, were justified and legally sustainable;

- Whether the TPO's rejection of segmental accounts maintained by the assessee on the ground of non-audit and disregarding the auditor's certificate was justified;

- Whether the selection of comparable companies by the TPO for benchmarking was appropriate and in accordance with the law;

- Whether the AO erred in levying interest under Sections 234A and 234B;

- Whether penalty proceedings initiated under Section 270A were justified;

- Whether the assessment proceedings were barred by limitation under Sections 153 read with 144C of the Act.

2. ISSUE-WISE DETAILED ANALYSIS

Jurisdiction of AO and TPO to make and pass TP reference and orders

The assessee challenged the jurisdiction of the AO and TPO to make the reference under Section 92CA(1) and to pass the TP order dated 28.10.2023. The grounds raised were that the AO (Technical Unit) lacked power to make such a reference and the TPO lacked jurisdiction to pass the order.

The Tribunal observed these grounds were general in nature and did not require specific adjudication. The statutory framework under Section 92CA(1) empowers the AO to refer the international transactions for determination of ALP to the TPO. The Tribunal implicitly upheld the jurisdiction of both authorities by proceeding to examine the substantive TP issues.

Compliance with DRP directions and final assessment order

The assessee contended that the AO did not issue the final assessment order in conformity with the DRP directions, violating Sections 144C(10) and 144C(13). The Tribunal noted these grounds were general and did not require detailed adjudication in this appeal.

Adjustment to ALP and rejection of Internal TNMM

The principal dispute concerned the TPO's adjustment of Rs. 4.29 Crores (later revised to Rs. 1.64 Crores) to the assessee's income by rejecting the Internal TNMM applied by the assessee and substituting it with an external TNMM. The assessee argued:

• The TPO did not disturb the method (TNMM) or the profit level indicator (PLI) but only replaced internal with external TNMM;
• The TPO rejected the segmental analysis on the ground that segmental results were unaudited, ignoring the auditor's certificate validating the segmental accounts;
• The profit margins declared by the assessee with Associated Enterprises (AE) and non-AE were -2.68% and -1.99% respectively, whereas the TPO's median PLI was 1.39%, within the statutory tolerance limit of +/-1%, thus no adjustment was warranted;
• The TPO incorrectly classified certain items like foreign exchange gains, duty drawback, export incentives, bad debts, and bank charges as non-operating expenses when computing PLI;
• The TPO failed to appreciate the business realities and rejected the assessee's TP analysis without demonstrating any inadequacy or infirmity in the same.

The Revenue contended that the TPO's approach was justified and relied upon the orders of the authorities below.

The Tribunal analyzed the legal framework under Section 92C(3) and 92CA(4), which require determination of ALP by applying the most appropriate method. The Tribunal referred to judicial precedents upholding the applicability of internal TNMM over external TNMM when justified by facts.

The Tribunal found that the TPO's sole basis for rejecting the internal TNMM was the non-audit of segmental results, despite the assessee filing an auditor's certificate validating these segments. The TPO summarily discarded this certificate without adequate reasoning.

Moreover, the Tribunal observed that even according to the TPO's own calculations, the PLI was within the +/-1% tolerance limit, which under the law negates the need for any adjustment.

The Tribunal also noted the TPO's incorrect treatment of certain accounting items as non-operating, which distorted the profit margin computation.

Consequently, the Tribunal held that the TPO's rejection of internal TNMM and substitution by external TNMM was not justified and the adjustments were unwarranted.

Selection of comparable companies

The assessee challenged the TPO's selection of certain companies as comparables that failed the export filter and were not functionally comparable in terms of functions, assets, and risk profile. The TPO also rejected functionally comparable companies without valid reasons.

The Tribunal noted these contentions but did not delve into detailed adjudication on this point, as the primary issue of rejection of internal TNMM and segmental accounts was dispositive.

Rejection of segmental accounts and auditor's certificate

The Tribunal relied on a coordinate bench decision holding that filing of audited segmental results is not necessary if the overall accounts are audited and figures are not disturbed by the TPO. The Tribunal held that the TPO's insistence on audited segmental results and rejection of the auditor's certificate was incorrect.

Levy of interest under Sections 234A and 234B and penalty under Section 270A

The assessee challenged the levy of interest and penalty proceedings initiated. The Tribunal did not specifically adjudicate these grounds in the present appeal.

Limitation of assessment proceedings

The assessee contended that the assessment proceedings were barred by limitation under Sections 153 read with 144C. This ground was not specifically adjudicated.

3. SIGNIFICANT HOLDINGS

The Tribunal held:

"The solitary ground on the basis of which the TPO has discarded the TP study of the assessee is that the segments filed by the assessee were not audited. The Ld. TPO has discarded the certificate of the auditor in a summary manner. Further, we observe that even if, we go by the conclusion of the TPO in arriving the PLI, then also the same is within the +-1% tolerance limit. Therefore, we are of the view that no adjustment is called for in this case and the adjustments made by the TPO are hereby deleted."

Respecting the coordinate bench decision, the Tribunal stated:

"Filing of audited segments is not necessary, if the accounts are audited and the figures mentioned therein are not disturbed by the TPO. Respectfully, following the decision of the Co-ordinate Bench, we are of the view that opinion of TPO with respect to filing of audited segments results is not correct."

Core principles established include:

• The internal TNMM method is acceptable and should not be rejected solely on the ground that segmental results are unaudited, especially when supported by auditor's certificate;
• Adjustments to ALP are unwarranted when the computed PLI is within the statutory tolerance limit of +/-1%;
• The TPO must provide reasoned and detailed findings before discarding the assessee's TP analysis;
• Audited segmental accounts are not mandatory if overall accounts are audited and segmental figures are not disturbed;
• The TPO's treatment of accounting items as non-operating must be correct and consistent with accounting principles;
• The AO and TPO must act within the scope of their jurisdiction and comply with DRP directions, but these were not specifically challenged in this appeal.

Final determinations:

• The reference made by the AO and the jurisdiction of the TPO were implicitly upheld;
• The adjustments made by the TPO to the ALP by rejecting internal TNMM and substituting external TNMM were quashed;
• The final assessment order incorporating these adjustments was set aside;
• The appeal was allowed in favour of the assessee.

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