2025 (8) TMI 594 - AT - Income Tax

TPO Must Reassess Transfer Pricing by Considering Actual Functions, Risks, and Activities Under Section 92C

M/s. Alpha-Elsec Defence & Aerospace Systems Pvt. Ltd. Versus The Deputy Commissioner of Income Tax, Circle 1 (1) (1), Bangalore.

M/s. Alpha-Elsec Defence & Aerospace Systems Pvt. Ltd. Versus The Deputy Commissioner of Income Tax, Circle 1 (1) (1), Bangalore. - TMI 1. ISSUES:1. Whether the Transfer Pricing Officer (TPO) erred in rejecting the assessee's economic analysis and conducting a fresh economic analysis for determination of the Arm's Length Price (ALP) of international transactions.2. Whether the TPO erred in disregarding segmental details and considering entity-wide margins for Transfer Pricing (TP) analysis.3. Whether the TPO erred in applying inappropriate comparability filters such as accounting year filter, manufacturing income threshold, persistent loss filter, government ownership exclusion, and turnover thresholds in selecting comparable companies.4. Whether the TPO erred in rejecting the assessee's selected comparable companies and accepting others that were functionally dissimilar or otherwise inappropriate.5. Whether the TPO erred in treating 'Bank Charges' as operating expenses in computing operating margins.6. Whether the TPO erred in failing to make appropriate adjustments for differences in working capital and risk profiles between the assessee and comparables.7. Whether the TPO erred in re-characterizing delayed trade receivables as loans and computing interest on delayed receivables.8. Whether the TPO erred in ignoring internal comparable data where no interest was charged or paid on delayed receivables or payables.9. Whether the TPO erred in ignoring the Reserve Bank of India Circular allowing extended export receivables collection periods due to COVID-19.10. Whether the TPO erred in imputing separate interest addition on delayed receivables despite alleged recovery of shortfall through excess income from associated enterprises.11. Whether the TPO erred in incorrectly computing arithmetic mean of margins and in not appreciating the joint venture nature of the assessee with no profit shifting motive.12. Whether the Assessing Officer (AO) erred in incorrectly considering income under Section 143(1) and raising disproportionate tax demand.13. Whether the AO erred in initiating penalty proceedings under Sections 274 read with 270A for underreporting of income.14. Whether the AO erred in computing interest under Sections 234A, 234B, and 234C on assessed income rather than on tax due on returned income.2. RULINGS / HOLDINGS:1. The court held that the TPO's rejection of the assessee's economic analysis was premature as the TPO relied solely on the Transfer Pricing Study Report (TPSR) without proper functional and risk analysis; the issue was restored for fresh examination.2. The TPO erred in disregarding segmental details and considering entity-wide margins; a segmental approach aligned with the assessee's business profile is necessary.3. The filters applied by the TPO for selecting comparables, including accounting year, manufacturing income percentage, persistent loss, government ownership, and turnover thresholds, were not appropriately justified and require reconsideration in light of the assessee's functional profile.4. The rejection of the assessee's selected comparable companies and acceptance of government-owned or functionally dissimilar companies was erroneous; comparability must be based on functional analysis and risk profile.5. The TPO's treatment of 'Bank Charges' as operating expenses was incorrect for computing operating margins.6. The TPO failed to make suitable adjustments for differences in working capital and risk profiles between the assessee and comparables, which is necessary for accurate ALP determination.7. Re-characterization of delayed receivables as loans and imposition of interest was not justified without considering the commercial expediency and business realities; this issue requires fresh consideration.8. Ignoring internal comparable data where no interest was charged or paid on delayed receivables or payables was an error.9. The TPO failed to consider the Reserve Bank of India Circular permitting extended collection periods for export receivables due to the COVID-19 pandemic, which should be factored in.10. Imputing separate interest addition on delayed receivables despite recovery of shortfall through excess income from associated enterprises was erroneous.11. The TPO erred in computing the arithmetic mean of margins without proper justification and failed to appreciate the joint venture nature of the assessee with no profit shifting motive.12. The AO was directed to verify and take correct income for computation purposes under Section 143(1), as the draft assessment order incorrectly considered income.13. Penalty proceedings under Sections 274 read with 270A were not upheld and were dismissed.14. Interest under Sections 234A, 234B, and 234C must be computed based on 'tax due on returned income' and not on assessed income; the AO's computation was erroneous.3. RATIONALE:The court applied the statutory provisions of the Income-tax Act, 1961, including Sections 92CA (Transfer Pricing), 143(1), 143(3), 144B, 144C, 234A, 234B, 234C, 274, and 270A. The court emphasized the importance of a correct functional and risk analysis in Transfer Pricing matters, referencing the arm's length principle and the need for comparability based on functions, assets, and risks (FAR analysis). The court noted that the TPO's reliance on the Transfer Pricing Study Report without independent verification of functions and risks constituted an error in law and fact. The court underscored that comparability filters must be applied consistently and justified by the factual matrix of the assessee's business. The decision recognized the commercial realities of the assessee's operations, including its limited role as an assembler under the direction of associated enterprises and lack of research and development activities, which materially affect comparability and ALP determination. The court also considered relevant RBI Circulars relating to extended export receivables collection periods due to the COVID-19 pandemic. The court directed a remand for fresh determination of ALP after proper functional analysis and comparability study, granting the assessee an opportunity of hearing. The court dismissed general and consequential grounds that lacked substantive merit or were consequential to the Transfer Pricing issue. There was no dissent or doctrinal shift noted in the judgment.