AE Transactions Must Be Benchmarked Separately When Segmental Data Exists: ITAT Delhi

Cornell Overseas Pvt Ltd Vs DCIT (ITAT Delhi)

The case concerns transfer pricing adjustments for Assessment Year 2007-08 involving a company engaged in the manufacture and export of readymade garments for ladies and children, as well as home furnishings. The appeal challenged the assessment order passed under Sections 254/143(3) read with Section 144C of the Income Tax Act pursuant to the directions of the Dispute Resolution Panel (DRP).

The assessee was a 100% Export Oriented Undertaking, with approximately 96% of its turnover arising from exports and the remaining 4% from local sales such as exhibitions. During the relevant year, it entered into international transactions relating to the sale of garments and home furnishings, samples for design and development, reimbursements received, and reimbursement of foreign travel expenses. For determining the Arm’s Length Price (ALP), the assessee adopted the Cost Plus Method (CPM), selecting 33 comparable companies and using Gross Profit on Cost as the Profit Level Indicator (PLI). The average markup of the comparables was computed at 15.90%, while the assessee’s own Gross Profit on Cost at the entity level was 29.14%, leading it to conclude that its international transactions were at arm’s length.

The Transfer Pricing Officer (TPO), however, rejected the assessee’s search process and substituted the Cost Plus Method with the Transactional Net Margin Method (TNMM), considering it the most appropriate method. The TPO adopted a fresh set of comparables and benchmarked the assessee’s profitability at the entity level. The assessee’s operating profit to total cost margin was determined at (-)2.08%, whereas the mean margin of the selected comparables was computed at 9.54%. Based on this analysis, the TPO proposed an adjustment by determining the ALP at the entity level.

Before the Tribunal, the assessee argued that the TPO and DRP erred in benchmarking profitability at the entity level rather than restricting the analysis to international transactions with Associated Enterprises (AEs). It contended that both AE and non-AE transactions related to the same business activities, namely the manufacture and wholesale export of garments and home furnishing products. The assessee submitted segmental profitability details showing a profit margin of 5.88% from AE transactions and 4.5% from non-AE transactions. Although the DRP declined to accept these figures because the segmental accounts were unaudited, the assessee maintained that only the profitability relating to international transactions could be benchmarked.

As an alternative argument, the assessee contended that even under an internal TNMM approach, the profitability earned from AE transactions exceeded that earned from non-AE transactions, thereby establishing that the international transactions were conducted at arm’s length.

The assessee also challenged the comparables selected by the TPO. It argued that several companies failed the Functional, Assets and Risk (FAR) analysis because they operated in fundamentally different businesses. According to the assessee, companies engaged in retail operations with retail outlets could not be compared with a wholesale exporter. Similarly, entities involved in fabric or yarn manufacturing were not comparable to manufacturers of readymade garments. The assessee further objected to the inclusion of companies engaged in sock manufacturing, contract manufacturing arrangements, leather garment manufacturing, and companies that had undergone mergers or acquisitions during the relevant year. It also argued that since it was a predominantly export-oriented enterprise, companies with export revenues constituting less than 75% of total sales should be excluded due to differences in market conditions and risk profiles. The assessee pointed out that the TPO had applied a 75% export revenue filter in Assessment Year 2008-09 despite similar facts and circumstances.

The Revenue argued that segmental analysis could be relied upon only if the segmental accounts had been audited. However, the Tribunal noted that the assessee’s assertion regarding the inapplicability of Accounting Standard-17 due to its turnover level had remained unrebutted. Consequently, the Tribunal accepted that the assessee was not statutorily required to maintain audited segmental accounts for AE and non-AE transactions. It held that the segmental analysis maintained by the assessee could not be rejected merely because it had not been audited.

The Tribunal further observed that where transactions are so closely interlinked that segregation is impracticable, profitability may be examined at the entity level. However, where transactions can be segregated, the law requires benchmarking to be confined to international transactions with AEs. Since the assessee had maintained segmental accounts certified by a Chartered Accountant, the Tribunal held that the Assessing Officer had erred in determining profitability at the entity level rather than focusing exclusively on international transactions.

Regarding the comparables, the Tribunal agreed with the assessee that entities engaged in retail operations could not be compared with a wholesale manufacturer and exporter because of differing FAR profiles. It also held that manufacturers of fabric and yarn, contract manufacturers of socks, leather garment manufacturers, and companies that had undergone mergers or acquisitions during the relevant period were not appropriate comparables. Further, given the assessee’s export-oriented nature, the Tribunal accepted that companies with export revenue below 75% of total sales should be excluded. The Tribunal found support for this view in the unrebutted assertion that the TPO had applied such a filter in the subsequent assessment year under similar circumstances.

In light of these findings, the Tribunal set aside the issue relating to comparables and remanded the matter to the TPO for fresh adjudication. It directed the TPO to exclude companies failing the FAR analysis and those with export revenue below 75% of total sales. The TPO was also instructed to reconsider the list of comparables, including Meenakshi (India) Ltd., which had been directed by the DRP to be included. Additionally, the Tribunal directed that the assessee be granted the benefit of the ±5% variation provided under the proviso to Section 92C(2) of the Act. Accordingly, the appeal was allowed for statistical purposes.

FULL TEXT OF THE ORDER OF ITAT DELHI

The above captioned appeal is preferred by the assessee against the assessment order dated 30.09.2016, passed by ld. Dy. Comm. Of Income Tax, Circle-6(2), New Delhi (hereinafter referred to as ‘ld. AO), passed u/s 254/143(3) r.w. 144C of the Income Tax Act, 1961 (hereinafter ‘the Act’) in pursuance of directions of the ld. Dispute Resolution Panel-1 (in short ‘ld. DRP’) dated 12.08.2016 pertaining to Assessment Year 2007-08.

2. The assessee has raised following revised grounds of appeal:-

1) The DRP/TPO erred in benchmarking the profitability/mark-up of assessee at entity level instead of profitability/mark-up from international transactions.

2) Without prejudice to Ground No 3, the profitability/mark-up of assessee from international transactions (AEs) is more than profitability/mark-up from independent transactions (non AEs) and therefore international transactions are at Arm’s length.

3) That DRP failed to appreciate; the functional, assets and risk profile of assessee and that some of the companies taken by TPO cannot be considered comparables as they had different Functional, Assets, Risk profile, cost structure, inconsistent performance, special/different economic circumstances and DRP further erred in upholding arbitrary filters applied by TPO

4) That DRP/TPO failed to correct errors in computation of operating profit mark-up of assessee and comparables.

5) That DRP/TPO erred in not allowing assessee the benefit of (+/-) 5% mentioned in the proviso to section 92C(2) of the Act.

The assessee craves leave to alter, amend or withdraw all or any grounds herein or add any further grounds as may be considered necessary either before or during the hearing.

4. Briefly, the assessee Cornell Overseas Private Limited, is engaged in the business of manufacturing and export of readymade garments for ladies and children and home furnishings. Mr. C. J. Cornell holds 50% of the shares and the other 50% of the shares are held by Mrs. Arpil Cornell. The assessee is a 100% Export Oriented Undertaking having the export turnover at approx. 96% of sales. The 4% local sales are exhibitions etc. The assessee has shown the following International Transactions during the year:

5. The assessee, for determining Arms length Price, has taken a set of 33 companies as comparables and has applied Cost Plus Method using PLI as Gross Profit on Cost where the average markup on Cost is 15.90%. The assessee own Gross Profit on Cost is calculated at 29.14% at the entity level hence the assessee claims its transactions with the associated enterprises are at arm’s length.

6. The TPO has rejected the entire search process carried out by assessee and applied Transaction Net Margin Method (TNMM) as Most Appropriate Method and a new set of search process and comparables. The TPO has worked out the OP/TC margin of the assessee at the entity level at -2.08% as against the mean operating profit of 9.54% on cost booked by the comparables and computed an Arms Length Price at Rs 1,19,48,300/- at entity level.

7. Aggrieved, the assessee is before us. With regard to ground 1, the ld counsel of the assessee argued that DRP/TPO erred in benchmarking profitability of assessee at entity level instead of profitability from international transactions. The nature of business of assessee in both AE and non AE segment is same i.e. manufacture and wholesale export of readymade garments and home furnishing items. The assessee submitted segmental profitability where profitability from AE transactions is 5.88% and the profitability from non-AE segment is 4.5%.

This was not accepted by DRP on the ground that segmental financials were not audited. It is further submitted that profitability from AE transactions (5.88%) only can be benchmarked and not profitability at entity level as done by the TPO/DRP.

8. Without prejudice, the ld AR submitted that profitability/mark-up from international transactions (AEs) is 5.88% more than profitability mark-up from independent transactions 4.5% (non AEs) and therefore, international transactions are at arm’s length using internal TNMM.

9. With respect to ground no. 3 & 4, the ld AR stated that the total no. of comparable companies taken by TPO in TP order is 17. It is submitted that the search is carried by TPO for companies operating in Apparels (Readymade Garments) Segment as well as companies where there is no manufacture of garments and the companies where there is fabric manufacturing and yarn manufacturing. Broadly assessee seeks exclusion of 10 companies on following grounds and inclusion of Meenakshi (India) Ltd (already directed by DRP but not taken by TPO as follows:

A. Companies in retail business with retail outlets – As per Rule 10B(2), companies operating in retail market are not comparable to wholesale as they have different FAR profile. The assessee is a manufacturer and wholesale exporter of readymade garments.

B. Manufacturer of fabric and/or yarn –

(i) Manufacture of fabric and /or yarn is different industry which is not comparable to Readymade garments (Apparels).

(ii) This is supported by the fact that TO applied search of companies in Readymade garments with product classification “Apparels (Readymade Garments)- refer page 9 of TP order. The companies where there is no manufacture of garments and the companies where there is fabric manufacturing and yarn manufacturing are rejected by TPO. (refer page 8 & 9 of TP Order)

C. Contract manufacturer of socks with 3 shifts – Socks are not comparable to manufacture of Apparel (Readymade garments). The cost structure, business model assets deployed and number of shifts operated by socks manufacturer are different leading to different FAR

D. Contract manufacturer: – The assessee is a full fledged risk bearing manufacturer and not comparable to contract manufacturers. The contract manufacturers have different cost structure, business model, assets deployed and risk profile.

E. Manufacturer of leather garments- Manufacture of leather garments requires different raw material, different type of investment in machineries. The manufacture of leather garments with large order sizes is completely different from designer garments manufactured by assessee which is based on unique styles with small order sizes and single tailor stitching.

2. Companies with Forex revenue/ sales less than 75% – The assessee is a 100% export oriented undertaking. Its export turnover is app 95% of sales. The 5% local sales are exhibitions etc. As per Rule 10B(2), and established judicial precedents, companies with different market conditions, including geographical locations, size of market, the laws and Govt orders in force, economic development ete cannot be compared as they have different risks and return profile. Therefore, companies having revenue from exports (forex revenue) less than 75% /sales are not comparable to assessee. The TPO applied 75% forex revenue/sales filter in AY 2008-09 (Copy of TPO order is enclosed) No forex filter applied in AY 2007-08 even though the facts and FAR of assessee is same in AY 2007-08 and AY 2008-09.

3. Companies having Merger and Acquisition – As per established judicial precedents, the companies with merger and acquisition during the year cannot be taken as comparable.

The ld AR gave the list of 17 companies taken by TPO and Meenakshi India Ltd. below for quick reference. The ld AR prayed for exclusion of companies failing FAR filter (Functional, Assets and Risk Profile filter) and companies having forex/sales less than 75%.

11. With respect to Ground No.5, it is submitted that the assessee should be given the benefit of +/-5% as provided in second proviso to sec 92C(2) of the Act.

12. Per contra, the ld. DR stated that there is nothing mentioned with regard to the quality of the work done by the assessee and the segmental analysis is to be considered when the segmental financial accounts are audited.

13. We have heard the rival submissions and perused the material available on record. We find that the TPO has rejected the cost plus method, which was adopted in the TP report and has applied external TNMM method as segmental financials were not audited. The issue therefore for our adjudication is with regard to adoption of Cost Plus Method as against the external TNMM method adopted by the TPO as also the comparables chosen to ascertain the ALP.

14. We find that that the assertion of the assessee that AS-17 is not applicable to the assessee as the turnover is small, about 24 to 25 Crores, which means that segmental reporting is not required as the assessee is the small/medium company, has gone unrebutted. In such circumstances, we agree with the assessee that it is not required to maintain financials for AEs segment or non-AEs segment. Nevertheless, the assessee has maintained the segmental analysis also which can not be rejected on the ground that it is not audited.

15. The next issue is with regard to benchmarking of profitability of assessee at entity level instead of profitability of international transactions. The assessee has placed reliance on the principal that only profitability from international transactions can be benchmarked on the basis of following cases-

i. CSR Technology (India) (P.) Ltd [2018] 90 com 85 (Delhi – Trib.) –

ii. Lummus Technology Heat Transfer BV [2014] 42 com 342 (Delhi – Trib.)-

iii. Messe Dusseldorf India (P.) Ltd. [2018] 90 com 159 (Delhi – Trib.)

iv. Paradigm Geophysical (I) (P.) Ltd [2016] 72 com 108 (Mumbai – Trib.)

v. Honeywell Electrical Devices & Systems India Ltd [2014] 42 com 223 (Chennai – Trib.) –

vi. Your Lifestyle (P.) Ltd [2018] 94 com 446 (Mumbai – Trib.)

16. We find that where the transactions are so intertwined so that segregation is difficult, profitability should be ascertained at entity level. Where transaction can be segregated, the law mandates that profitability from AE Transactions can only be benchmarked and not profitability at entity level. In the case of the assessee, the assessee has maintained segmental accounts, certified by the CA, and hence we agree with the assessee that the Assessing Officer has committed mistake in determining the profitability at entity level instead of international transactions.

17. We however, are of the opinion, that where the TPO applies External TNMM method, the comparables companies chosen should have comparable Functional, Assets and Risk Profile. We agree with the assessee that as per Rule 10B(2) and established judicial precedents, companies with retail business with retail outlets cannot be compared with wholesale manufacturer as they have different FAR profile; Similarly, Manufacturer of fabric and/or yarn is different industry which is not comparable to Readymade garments (Apparels) as in the case of the assessee. Similarly, Contract manufacturer of socks with 3 shifts, is not comparable to manufacture of Apparel (Readymade garments) as they have different FAR; Similarly, Manufacture of leather garments are not comparable to the assessee as they are completely different from designer garments manufactured by assessee. We also agree with assessee that the companies with merger and acquisition during the year cannot be taken as comparable. Further, the assessee being a 100% export oriented undertaking with export turnover app 95% of sales, cannot be compared with companies having revenue from exports (forex revenue) less than 75% /sales. We are fortified in our view by the fact that the assessee’s assertion that the TPO applied 75% forex revenue/sales filter in AY 2008-09 whereas no forex filter applied in AY 2007-08 even though the facts and FAR of assessee is same in AY 2007-08 and AY 2008-09, has gone unrebutted.

18. In view of the above discussion, we are of the considered view that the issue of comparables be set aside to the file of the TPO for a fresh adjudication with the direction that the companies failing FAR filter (Functional, Assets and Risk Profile filter) and companies having forex/sales less than 75% be excluded. The TPO is directed to consider the list of 17 companies taken by TPO as well as Meenakshi India Ltd, a company directed by the DRP to be included in the comparables. Needless to add that the assessee be allowed the benefit of (+/-) 5% mentioned in the proviso to section 92C(2) of the Act. The grounds are disposed off in the aforesaid terms.

19. In the result, the appeal in ITA 850/Del/2025 is allowed for statistical purposes.

Order was pronounced in the open court on 2^nd June, 2026.