TNMM comparability requires idle capacity and working capital adjustments where operating differences distort margins and profitability.

Under TNMM, comparability must neutralise material differences in capacity utilisation and operating cycle effects. Idle capacity adjustment in the EPC segment was warranted where the taxpayer showed ramp-up in operations, under-absorption of fixed costs, and a supported methodology, and the denial was therefore unsustainable. Working capital adjustment also had to capture all relevant operating current assets and liabilities, including items such as unbilled revenue, prepaid expenses, customer advances, advance recoverables and inventories, because they affect liquidity and profitability; the computation was therefore to be recomputed on the correct operating base. Only consequential verification by the tax authorities remained.

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Issues: (i) Whether the denial of idle capacity adjustment in the EPC segment was sustainable; (ii) whether working capital adjustment under TNMM had to include all relevant operating current assets and liabilities.

Issue (i): Whether the denial of idle capacity adjustment in the EPC segment was sustainable.

Analysis: Under TNMM, comparability must account for functional differences, asset deployment, risk profile, and the effect of underutilization of capacity. In a ramp-up or first full year of operations, disproportionate fixed costs may depress margins unless idle capacity is adjusted. The assessee showed a clear operational ramp-up, a substantial improvement in revenue and cost absorption in the succeeding year, and a documented methodology for the adjustment. No material defect in the methodology or comparable material demonstrating superior capacity utilisation was established.

Conclusion: The denial of idle capacity adjustment was not sustainable, and the adjustment was allowed in favour of the assessee.

Issue (ii): Whether working capital adjustment under TNMM had to include all relevant operating current assets and liabilities.

Analysis: Working capital adjustment must reflect the tested party's actual operating cycle and should include all material operating current assets and liabilities, while excluding only non-operating or financial items. Unbilled revenue, prepaid expenses, advances from customers, advance recoverables, and inventories materially affect liquidity and profitability and therefore form part of the working capital computation when relevant to business operations. The revised computation was supported by detailed workings and accepted practice.

Conclusion: Working capital adjustment was directed to be recomputed by including the relevant operating current assets and current liabilities, in favour of the assessee.

Final Conclusion: The transfer pricing adjustment was directed to be reworked after granting idle capacity adjustment and recomputing working capital adjustment on the correct operating base, leaving only consequential verification by the assessing authorities.

Ratio Decidendi: Under TNMM, idle capacity and working capital effects must be neutralised through appropriate adjustments where a tested party demonstrates capacity underutilisation or material operating cycle differences, and such adjustments cannot be denied without a reasoned comparability basis.

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