2025 (8) TMI 204 - AT - Income Tax

TPO's allocation of indirect expenses based on export revenue flawed under Transfer Pricing rules, assessee's method accepted

The ITAT Delhi held that the TPO's allocation of indirect expenses based on export revenue proportion was flawed, as these expenses were also attributable ... TP adjustment - arm’s length price difference on sale of the traded goods - computation of operating margin and TPO's computation of operating margin - HELD THAT:- We find that the dispute raised by the ld DRP was only with regard to capital expenses vs. revenue expenses. Genuinity of incurrence of such expenses towards the trading activity and abandoned project was not doubted. TPO had taken the indirect expenses in proportion to the export revenue to total revenue and had allocated the said expenses more to the trading activity thereby resulting in tinkering of assessee’s operation margin, whereas the assessee had taken the actual expenses incurred in its trading activity and allocated the same for working out its operation margin. Either way, the assessee had already disallowed the entire indirect expenses in the computation of income. We hold that action of the lower authorities in considering the total indirect expenses in proportion to the export revenue to total revenue is totally flawed as the very same indirect expenses were also needed to be allocated largely to the abandoned project. Because of tinkering with the assessee’s margin by the ld TPO, the entire dispute arose in the instant case. Hence, we have no hesitation in directing the ld TPO to accept the assessee’s operating margin @6.24%. No transfer pricing adjustment need to be made in respect of trading activity. Accordingly, ground raised by the assessee are allowed. ISSUES: Whether the transfer pricing adjustment on sale of traded goods based on arm's length price difference is justified.Whether the Operating Profit/Operating Cost (OP/OC) margin calculated by the Transfer Pricing Officer (TPO) at (-) 35.46% is appropriate as against the assessee's reported margin of 6.24%.Whether the TPO's method of considering employee benefit expenses and other expenses proportionate to export revenue to total revenue is correct.Whether the rejection of all comparables selected by the assessee and selection of 15 new comparables by the TPO without specific reasons is valid.Whether the computation of arm's length price adjustment of Rs. 1,11,76,537/- on sale of traded goods is sustainable. RULINGS / HOLDINGS: The transfer pricing adjustment on sale of traded goods is not justified as the assessee's operating margin of 6.24% should be accepted instead of the TPO's (-) 35.46% margin.The TPO's approach of proportionately allocating employee benefit and other expenses based on export revenue to total revenue is flawed because these expenses largely pertain to an abandoned project and not to trading activities.The rejection of all comparables selected by the assessee and the selection of 15 new comparables by the TPO without giving specific reasons is erroneous.The arm's length price adjustment of Rs. 1,11,76,537/- computed by the TPO is based on an incorrect operating margin and therefore cannot be sustained.Accordingly, no transfer pricing adjustment is required in respect of the trading activity, and the assessee's reported income should be accepted. RATIONALE: The court applied the provisions of the Income Tax Act, 1961, specifically sections 92CA(3), 143(3), 143(13), 144B, and 144C(5) relating to transfer pricing and assessment procedures.The assessee's Transfer Pricing Study Report adopted the Transactional Net Margin Method (TNMM) using Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI), selecting five comparables with a PLI of 2.32%, resulting in an assessee margin of 6.24%.The TPO rejected the assessee's comparables without specific reasons, selected 15 new comparables, and recalculated the operating margin at (-) 35.46% by allocating employee benefit and other expenses proportionate to export revenue, ignoring the fact that a significant portion of these expenses related to an abandoned manufacturing project voluntarily disallowed by the assessee.The Dispute Resolution Panel (DRP) directed the Assessing Officer to examine the issue of expense allocation further, recognizing the distinction between capital and revenue expenses but not disputing the genuineness of expenses related to the abandoned project.The court found that the TPO's allocation of expenses was incorrect as it failed to segregate expenses related to the abandoned project from trading activities, resulting in a distorted operating margin and flawed transfer pricing adjustment.The court emphasized that since the assessee had already disallowed the indirect expenses related to the abandoned project in its income computation, the TPO's approach led to double counting and was therefore unsustainable.No doctrinal shift or dissent was noted; the court adhered to established transfer pricing principles and statutory provisions, ensuring that only genuine expenses related to the international transaction are considered for arm's length price determination.