Mumbai Tribunal holds that segmental accounts should be considered for the computation of the Profit Level Indicator

Brief: – The Mumbai bench of the Income Tax Appellate Tribunal (Tribunal) recently pronounced its ruling in the case of M/s Tecnimount ICB Pvt. Ltd. Vs ACIT, Mumbai, ITA No. 7098/Mum/2010, on transfer pricing issues arising from equipment supplied and technical services rendered by the Taxpayer to its Associated enterprises (AEs). The Tribunal ruled in favour of the Taxpayer stating that segmental accounts should be considered for the calculation of the Profit Level Indicator (PLI).

Facts of the case

Tecnimount ICB Pvt. Ltd., a joint venture between Tecnimount Edison Group, Italy (“Tecnimount Group”) and Kapadia Group, India, is engaged in provision of engineering design and field construction supervision services to various entities in Tecnimount Group (AEs). The services provided by the Taxpayer’s technical personnel are rendered from India, from Tecnimount Group offices or at the field construction sites. For provision of these services, the Taxpayer is remunerated on an hourly basis on actual man-hours spent. The Taxpayer had transactions with AEs as well as non-AEs for financial year (FY) 2005-06. The Taxpayer had computed the PLI based on segmental accounts for its transactions with AEs. During the proceedings before the Transfer Pricing Officer (TPO) the Taxpayer had submitted the segmental results to support the computation.

However, the Transfer Pricing Officer (TPO) observed that the segmental data provided by the Taxpayer lacked allocation details and was based on accounting policy difficult to comprehend. Further, the TPO remarked that since no authenticated documents were produced by the Taxpayer to prove the genuineness of split profit and loss account, the segmental results could not be relied upon. Hence the TPO computed the PLI at the entity level. For the computation, single year data was considered. Also, the TPO rejected the loss making companies as comparables. In view of the above, the TPO proposed an adjustment.

Being aggrieved by the transfer pricing order, the Taxpayer filed its objections before the Dispute Resolution Panel (DRP) on the following grounds:

i) rejection of segmental accounts;

ii) use of single year data;

iii) excluding other income from operative income;

iv) rejection of loss making company; and

v) adjustment to the total cost (rather than cost attributable to AE)

The Taxpayer also furnished audited segmental results which were rejected by the DRP. The DRP agreed with the TPO on the rejection of segmental accounts, adopting single year data and adjustment to the total cost. Further, the DRP observed that the Taxpayer is not entitled to the benefit of 5% variation from the arithmetic mean as per proviso to Section 92C(2) since the arm’s length price does not fall within the 5% range. However, the DRP did not agree with the TPO in excluding the loss making companies as comparables though the TPO did not comply with this direction of the DRP when passing the final order.

Ruling of the Tribunal

The Taxpayer aggrieved by the order of the TPO pursuant to the DRP directions, appealed before the Tribunal. The Tribunal adjudicated on the grounds of appeal relating to the segmental analysis made by the Taxpayer. The salient aspects of the Tribunal’s order are as follows:

• In accordance with Section 144C and Rule 4 of Income Tax (Disputes Resolution Penal) Rules, 2009, the DRP should have admitted the audited segmental accounts submitted by the Taxpayer. The objection of the accounts being unaudited was a procedural requirement and once the same was complied with, the audited data should have been admitted. Thus the Tribunal admitted the audited segmental results filed by the Taxpayer.
• In accordance with Sections 92 to 94, segmental results should be considered for the calculation of the PLI and not the entity level results.
• The Tribunal accepted loss making companies as comparables
• As regards the benefit of 5% variation from the arithmetic mean, the Tribunal relied upon the decision in the case of Sony India Pvt. Ltd. v/s DCIT, (2008) 114 ITD 448 (Del.). Following the decision the Tribunal held that the Taxpayer is entitled to the marginal benefit irrespective of whether the arm’s length price falls within the 5% range since the provision (Prior to amendment under Finance (No 2) Act, 2009)  to section 92C(2) contemplated adjustment to be made at the option of the assesse.

Conclusion- The key takeaways of this ruling relate to the use of segmental accounts with underlying explanations to support allocation of direct and indirect costs. Arbitrary allocation of direct costs or use of allocation keys is unlikely to be accepted during assessment proceedings. Further the ruling also dealt with the scope of powers of the DRP in regard to taking into consideration evidence furnished by the Taxpayer before issuing any directions.