Transfer pricing under TNMM covers operating items, comparable selection review, and no separate overdue receivables interest adjustment in specified cases.

Transfer pricing under TNMM is discussed on three points: export incentive is treated as operating income and miscellaneous expenses as operating expenses for the assessee and comparables where relevant data is available, requiring margin recomputation under Rule 10CA; selection or rejection of comparables may need reconsideration where the basis of the related party transactions filter is unclear or functional comparability is disputed, with corresponding recomputation of margins; and a separate adjustment for notional interest on overdue receivables from associated enterprises is not warranted where the assessee is debt-free and does not charge interest from non-associated enterprises. The note presents these principles as governing the transfer pricing analysis.

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Issues: (i) Whether export incentive and miscellaneous expenses were to be treated as operating items for transfer pricing margin computation and whether the margins of the assessee and comparables were to be recomputed under Rule 10CA of the Income-tax Rules, 1962; (ii) Whether the rejection and inclusion of comparables on the basis of the related party transactions filter and functional comparability required reconsideration; (iii) Whether notional interest on overdue receivables from associated enterprises was warranted.

Issue (i): Whether export incentive and miscellaneous expenses were to be treated as operating items for transfer pricing margin computation and whether the margins of the assessee and comparables were to be recomputed under Rule 10CA of the Income-tax Rules, 1962.

Analysis: The treatment of export incentive and miscellaneous expenses was held to follow the Tribunal's earlier view that export incentive forms part of operating income and miscellaneous expenses constitute operating expenses, both for the assessee and for the comparables wherever relevant data is available. The margin working was also directed to be considered in terms of Rule 10CA, and the transfer pricing margin of the comparables was required to be redetermined on that basis.

Conclusion: The issue was decided in favour of the assessee, with directions to recompute the margins accordingly.

Issue (ii): Whether the rejection and inclusion of comparables on the basis of the related party transactions filter and functional comparability required reconsideration.

Analysis: The basis of computation of the 25% related party transactions filter was not shown for the exclusion of the disputed comparables, and one newly included comparable was said to be functionally dissimilar. The matter was therefore required to be revisited by the Transfer Pricing Officer after furnishing the basis of computation and reconsidering functional similarity in the light of the assessee's objections. The margin of one comparable was also required to be recomputed after treating miscellaneous expenses as operating in nature.

Conclusion: The issue was partly decided in favour of the assessee and remitted for reconsideration.

Issue (iii): Whether notional interest on overdue receivables from associated enterprises was warranted.

Analysis: The adjustment on account of overdue receivables was held to be covered by the Tribunal's earlier ruling that, in the case of a debt-free assessee which does not charge interest from non-associated enterprises as well, no separate transfer pricing adjustment for notional interest on overdue receivables is warranted.

Conclusion: The issue was decided in favour of the assessee and the adjustment was deleted.

Final Conclusion: The transfer pricing adjustments were sustained only to the limited extent requiring reconsideration and recomputation on certain comparables, while the notional interest adjustment was deleted, resulting in a partial success for the assessee.

Ratio Decidendi: For transfer pricing under TNMM, export incentive is operating income, miscellaneous expenses are operating expenses where relevant data exists, and notional interest on overdue receivables is not separately warranted for a debt-free assessee that does not charge such interest from non-associated enterprises.

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