External TNMM and segmental comparability in transfer pricing require real functional and risk evidence, not mechanical filtering.

A cost-plus limited-risk manufacturer was held not to fail External TNMM merely because a restrictive search excluded comparables; export intensity and broad functional objections were insufficient without showing material impact on profitability, so External TNMM remained the appropriate benchmark. The AE and Non-AE segments were found economically incomparable because the Non-AE business bore entrepreneurial market, pricing and credit risks, and no reliable risk adjustment supported Internal TNMM. Audited segmental accounts could not be rejected or re-cast absent specific defects in accounting policy or allocation keys, so the transfer pricing re-casting was set aside and the additions were deleted.

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Issues: (i) Whether the rejection of External TNMM and the finding that no reliable external comparables were available was justified; (ii) whether the AE and Non-AE segments were comparable so as to justify Internal TNMM as the most appropriate method; (iii) whether the audited segmental accounts could be rejected and the segmental results re-cast for transfer pricing purposes.

Issue (i): Whether the rejection of External TNMM and the finding that no reliable external comparables were available was justified.

Analysis: The assessee had undertaken a structured comparability search and applied filters aimed at identifying routine contract manufacturers suited to a limited-risk cost-plus model. The rejection of the entire comparable set was based on a rigid and cumulative application of turnover, export and related party transaction filters, together with broad functional objections, without a satisfactory economic demonstration that those filters were material to profitability in the tested segment. In a cost-plus manufacturing model where export, credit and market risks are not borne by the tested party, export intensity of third-party comparables is not by itself determinative. The record also showed that segmental data existed for several entities and that outright rejection of all comparables was too restrictive.

Conclusion: The rejection of External TNMM and the finding of non-availability of comparables was not justified; External TNMM remained the appropriate method, and the assessee's benchmarking was accepted.

Issue (ii): Whether the AE and Non-AE segments were comparable so as to justify Internal TNMM as the most appropriate method.

Analysis: The segmental results showed a marked margin differential between the AE segment and the Non-AE segment. The AE segment operated as a limited-risk contract manufacturer on a cost-plus basis, while the Non-AE segment exhibited entrepreneurial returns consistent with bearing market, pricing and credit risks. TNMM comparability depends on functions, assets and risks, not merely on similarity of products. In the absence of any risk adjustment or other reliable basis to equate the two segments, the Non-AE segment could not be treated as a dependable internal comparable. The earlier remand did not permit revival of an approach already disapproved in principle.

Conclusion: The AE and Non-AE segments were not economically comparable, and the adoption of Internal TNMM was unsustainable and against the assessee.

Issue (iii): Whether the audited segmental accounts could be rejected and the segmental results re-cast for transfer pricing purposes.

Analysis: The audited segmental accounts were supported by the financial records, and no specific defect in accounting policy, allocation key, or compliance with accounting standards was identified. The re-casting exercise was effectively built around a preconceived margin for the AE segment and a residual allocation of profitability to the Non-AE segment, which is not a permissible substitute for actual audited results absent demonstrated defects. Once Internal TNMM was rejected and External TNMM held applicable, the foundation for such re-casting disappeared.

Conclusion: The audited segmental accounts could not be rejected in entirety, and the re-casting of segmental results was set aside against the Revenue.

Final Conclusion: The transfer pricing additions were deleted, the international transactions were held to be at arm's length under External TNMM, and both appeals were allowed, with consequential matters left to be given effect in accordance with the order.

Ratio Decidendi: In transfer pricing matters, a cost-plus limited-risk manufacturer cannot be benchmarked by a mechanically restrictive comparable search or by internal comparison with an entrepreneurial segment unless functional and risk comparability is established on reliable evidence; audited segmental results cannot be displaced without specific defects.

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