Transfer pricing and depreciation principles: internal TNMM upheld, CUP rejected, and statutory book-profit adjustments limited by the text

Internal TNMM was accepted over CUP for benchmarking finished-goods sales to associated enterprises because the AE and non-AE transactions differed materially in contractual terms, economic circumstances, volumes, payment terms and functions; the CUP adjustment was deleted. Sales promotion and marketing services from AEs were held to be evidenced and at arm's length, so the adjustment was deleted. Additional depreciation was denied on replacement spares and parts because this was not acquisition of new plant and machinery, but allowed on tanks as part of eligible plant. Prior period expenses were not an authorised adjustment under section 115JB, so the book-profit addition was deleted. Interest on capital work in progress could not be capitalised without a proved nexus between borrowings and fixed assets. Weighted deduction under section 35(2AB) could not be restricted merely because Form 3CL did not quantify expenditure for that year.

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Issues: (i) Whether internal TNMM or CUP was the most appropriate method for benchmarking the sale of finished goods to associated enterprises, and whether transfer pricing adjustments made on CUP basis were justified; (ii) whether the adjustment for availing sales promotion and marketing services from associated enterprises was sustainable; (iii) whether additional depreciation was allowable on replacement of spares and parts and on tanks; (iv) whether prior period expenses could be added back while computing book profit under section 115JB; (v) whether interest on capital work in progress could be capitalised in the absence of a proved nexus between borrowed funds and fixed assets; and (vi) whether weighted deduction under section 35(2AB) could be restricted merely because the DSIR Form 3CL did not quantify the expenditure.

Issue (i): Whether internal TNMM or CUP was the most appropriate method for benchmarking the sale of finished goods to associated enterprises, and whether transfer pricing adjustments made on CUP basis were justified.

Analysis: The transactions for the year were held to be identical to those in the assessee's earlier years, where the Tribunal had accepted internal TNMM and rejected CUP because the AE and non-AE transactions differed materially in contractual terms, economic circumstances, volumes, payment terms, functional profile, and related adjustments. The availability of internal comparables did not by itself make CUP reliable, and the principle of consistency required following the earlier binding view, which had also been affirmed in the assessee's case by the High Court.

Conclusion: Internal TNMM was correctly accepted as the most appropriate method, and the CUP-based transfer pricing adjustment was rightly deleted.

Issue (ii): Whether the adjustment for availing sales promotion and marketing services from associated enterprises was sustainable.

Analysis: The issue was covered by the Tribunal's earlier decisions in the assessee's own case, where the services were accepted as evidenced and the arm's length nature of the payment had been upheld. No distinguishing material for the year under appeal was shown, and the Revenue did not produce any contrary binding decision or demonstrate any infirmity in the earlier reasoning.

Conclusion: The deletion of the adjustment for sales promotion and marketing services was upheld.

Issue (iii): Whether additional depreciation was allowable on replacement of spares and parts and on tanks.

Analysis: Additional depreciation is available only on new plant and machinery acquired during the year. Replacement of spares and parts of existing machinery does not amount to acquisition of new plant and machinery, so the allowance granted on that basis was not justified. For the tanks, however, the materials showed that they formed part of the plant and machinery used for storage of hazardous materials, and the normal depreciation treatment supported their character as eligible machinery.

Conclusion: Additional depreciation on replacement of spares and parts was disallowed, but additional depreciation on tanks was allowed.

Issue (iv): Whether prior period expenses could be added back while computing book profit under section 115JB.

Analysis: Prior period expenses are not one of the permitted adjustments under the Explanation to section 115JB. In the absence of a statutory provision permitting such adjustment, the addition made while computing book profit was not sustainable.

Conclusion: The addition of prior period expenses while computing book profit under section 115JB was rightly deleted.

Issue (v): Whether interest on capital work in progress could be capitalised in the absence of a proved nexus between borrowed funds and fixed assets.

Analysis: The Assessing Officer proceeded on presumption that the ECB borrowings were used for capital purposes, but no nexus between the borrowed funds and the capital assets under construction was established. In the absence of such linkage, interest capitalisation could not be sustained.

Conclusion: The deletion of the interest capitalisation addition was upheld.

Issue (vi): Whether weighted deduction under section 35(2AB) could be restricted merely because the DSIR Form 3CL did not quantify the expenditure.

Analysis: For the relevant year, the statutory requirement of DSIR quantification had not yet been introduced as a condition for allowance of deduction. The disallowance was therefore made on an inapplicable basis.

Conclusion: The assessee's claim under section 35(2AB) was rightly allowed.

Final Conclusion: The Revenue succeeded only on the limited question of additional depreciation on replacement of spares and parts, while the transfer pricing deletions, the marketing services deletion, the book-profit adjustment, the interest-capitalisation deletion, the tanks-related depreciation, and the deduction under section 35(2AB) were sustained.

Ratio Decidendi: Where AE and non-AE transactions differ materially in economically relevant factors and reliable adjustments are not possible, internal TNMM may be the most appropriate method over CUP; and book-profit computation under section 115JB cannot include adjustments not expressly authorised by the statute.

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