2018 (7) TMI 1972 - AT - Income Tax

TP Adjustment - comparable selection - functional dissimilarity - HELD THAT - As far as exclusion of 3 companies viz., Bharath Electronics Ltd BEL ., MIC Electronics Ltd. and Bharath Heavy Electricals Ltd. BHEL is concerned, it is clear from the order of DRP that the 3 companies were manufacturers of equipments, whereas the assessee was only manufacture of components which are used in making equipments. This functional difference has been rightly noticed by the DRP in excluding these 3 companies from the list of comparable companies. Besides the above, it is also seen that BHEL is engaged in diverse activities of manufacture of power station equipments like boilers, turbines, etc. In terms of size, it is to be regarded as a very big company not comparable with that of assessee. No grounds to interfere with the order of DRP, consequently we dismiss the relevant grounds of appeal of the revenue in this regard. Determining the PLI, depreciation should be regarded as part of operating cost - HELD THAT - There is substantial variation in the manner of charging depreciation by the Assessee and the comparable companies. The question therefore is as to whether the profits to be compared should be ignoring the depreciation charge/expenditure. An identical issue was considered by this Tribunal in the case of Honeywell Technology Solutions Lab v. DCIT, 2013 (9) TMI 189 - ITAT BANGALORE wherein relied case of 24/7 Customer.com (P.) Ltd. v. Dy. CIT 2013 (1) TMI 45 - ITAT BANGALORE held that if there are differences in the method of charging depreciation between the Tested party and the comparable companies, then there would be impact on the operating profits and in such circumstances it is safe to consider PLI without considering depreciation as part of the operating cost. The Tribunal in the case of BA Continuum India Pvt Limited v. ACIT 2014 (9) TMI 258 - ITAT HYDERABAD took the view that depreciation had an impact on the profit margin of the assessee. The Assessing Officer was directed to use the profit level indicator as profit before depreciation, interest and taxes to recompute the arm s length price. It would be just and appropriate to set aside the order of DRP and the final order of assessment and direct the AO/TPO to consider the determination of PLI by considering the ratio of the decisions referred to above. Appeal by the revenue is treated as partly allowed for statistical purposes.

Summary

Issues Involved:
1. Exclusion of Bharat Electronics Ltd., MIC Electronics Ltd., and Bharat Heavy Electricals Ltd. as comparables under the TNMM method.
2. Inclusion of depreciation as part of operating expenses for determining the Profit Level Indicator (PLI).

Issue-wise Detailed Analysis:

1. Exclusion of Bharat Electronics Ltd., MIC Electronics Ltd., and Bharat Heavy Electricals Ltd. as comparables:

The revenue challenged the decision of the Dispute Resolution Panel (DRP) to exclude Bharat Electronics Ltd., MIC Electronics Ltd., and Bharat Heavy Electricals Ltd. as comparables for the assessee under the Transactional Net Margin Method (TNMM). The DRP had excluded these companies on the grounds of functional differences and size disparities. Specifically, the DRP noted that Bharat Electronics Ltd. manufactures radar communication equipment and other advanced systems for defense use, which are not comparable to the Frequency Control Products (FCP) manufactured by the assessee. Additionally, Bharat Heavy Electricals Ltd. is engaged in the manufacture of power station equipment and other diverse activities, making it significantly different from the assessee's business. MIC Electronics Ltd. was also considered functionally different due to its involvement in LED display systems and other unrelated products. The Tribunal upheld the DRP’s decision, agreeing that the functional differences and size disparities justified the exclusion of these companies as comparables.

2. Inclusion of depreciation as part of operating expenses for determining the Profit Level Indicator (PLI):

The revenue also contested the DRP’s decision to exclude depreciation from operating expenses when determining the PLI. The DRP had agreed with the assessee’s submission that depreciation should not be considered as part of operating expenses, citing substantial variations in the method of charging depreciation between the assessee and the comparable companies. The DRP referenced the decision of the Andhra Pradesh and Telangana High Court in the case of BA Continuum India Pvt. Ltd., which supported the exclusion of depreciation to arrive at a correct comparability. The Tribunal reviewed the submissions and the relevant case law, including decisions in Honeywell Technology Solutions Lab v. DCIT and 24/7 Customer.com (P.) Ltd. v. Dy. CIT, which supported the view that differences in depreciation methods impact operating profits. Consequently, the Tribunal directed the Assessing Officer (AO) and the Transfer Pricing Officer (TPO) to reconsider the determination of PLI by excluding depreciation, in line with the cited precedents.

Conclusion:

The Tribunal upheld the DRP’s decision to exclude Bharat Electronics Ltd., MIC Electronics Ltd., and Bharat Heavy Electricals Ltd. as comparables due to functional differences and size disparities. Additionally, the Tribunal directed the AO/TPO to reconsider the determination of PLI by excluding depreciation from operating expenses, following established judicial precedents. The appeal by the revenue was thus partly allowed for statistical purposes.

Pronouncement:

The judgment was pronounced in the open court on July 20, 2018.