2018 (1) TMI 1044 - AT - Income Tax

TPA - ALP determination - comparable selection criteria - whether the quantum of turnover of non-AE i.e. uncontrolled transactions with total turnover has to be considered for treating as comparables? - non-adoption of internal TNMM - Held that - Profitability of the organization will have an impact when there is huge underutilization of the capacity. There has to be an adjustment internally within the organization by allocating overhead to the segments, for which, capacity was utilized and for idle capacity. Otherwise, there has to be an adjustment of idle capacity when compared with outside comparables. In the given case, assessee has not properly maintained allocation of overheads, even though, assessee has relied on the services of Cost Accountant, who has allocated the overheads only to the segments, in which, turnovers were recorded and failed to allocate for the idle capacity. Therefore, in our considered view, assessee has to submit the segmental results based on the absorption of overhead on capacity utilization and idle capacity. This is imperative that assessee allocates manufacturing overhead, administrative overhead and other fixed overheads on the basis of capacity utilization. As advisable for the assessee to submit segment-wise report i.e. export to AE, export to non-AE, domestic sales to non-AE and idle capacity. Considering the above factual matrix, we direct the TPO/AO to consider the above revised segmental profit and loss reports of the assessee and arrive of the ALP adjustment by considering non-AE transactions as one of the comparable in determining ALP by following TNMM method afresh - remit this file back to the file of TPO/AO for determining the ALP afresh. - Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Non-selection of internal TNMM as the most appropriate method.
2. Adjustment for low capacity utilization.

Issue-Wise Detailed Analysis:

1. Non-Selection of Internal TNMM as the Most Appropriate Method:
The assessee contended that the internal TNMM should be adopted due to the functional similarity between AE and non-AE segments. The assessee argued that the products sold to both segments were identical, and the functions performed, assets employed, and risks assumed were similar. The TPO, however, rejected this claim, stating that the segmental details provided by the assessee were unreliable due to the allocation of direct and indirect costs without any basis. The DRP upheld the TPO's decision, noting that the non-AE segment was a minuscule part of the total exports and lacked sufficient details for a valid comparison. The Tribunal, however, found merit in the assessee's argument, citing previous judicial pronouncements that supported the use of internal comparables even if the turnover of non-AE transactions was smaller. The Tribunal directed the TPO/AO to reconsider the revised segmental profit and loss reports, including non-AE transactions as comparables in determining the ALP using the TNMM method afresh.

2. Adjustment for Low Capacity Utilization:
The assessee argued that low capacity utilization due to lesser demand resulted in some fixed costs remaining unrecovered, leading to lesser profitability. The DRP rejected this objection, citing previous years' decisions and stating that no adjustment for capacity utilization was warranted. The Tribunal noted that the assessee had not maintained records to indicate the unabsorbed overheads related to underutilization of capacity. The Tribunal emphasized the need for an adjustment for idle capacity when comparing with external comparables. It directed the assessee to submit segmental results based on the absorption of overheads on capacity utilization and idle capacity. The Tribunal instructed the TPO/AO to consider the revised segmental profit and loss reports and determine the ALP adjustment afresh.

Conclusion:
The Tribunal allowed the appeal for statistical purposes, directing the TPO/AO to reconsider the ALP determination by including non-AE transactions as comparables and making necessary adjustments for low capacity utilization. The other alternate grounds raised by the assessee were dismissed.