TNMM Margin Comparison Must Apply Depreciation Consistently, Rules ITAT Kolkata

Manaksia Steels Limited Vs DCIT (ITAT Kolkata)

Different Depreciation Treatment for Assessee and Comparables Distorts TNMM: ITAT Deletes ₹1.14-Crore Transfer-Pricing Adjustment

Summary: The Kolkata Bench of the Income Tax Appellate Tribunal has deleted a transfer-pricing adjustment of ₹1,13,83,297, holding that the Transfer Pricing Officer adopted an inconsistent treatment of depreciation while computing the Profit Level Indicator of the assessee and the comparable companies.

The Tribunal found that depreciation was included in the assessee’s operating cost but excluded while computing the operating margins of the comparables. Such an inconsistent methodology resulted in an anomalous and fallacious comparison. When depreciation was excluded from the assessee’s operating cost on the same basis as the comparables, the assessee’s margin increased from 3.36% to 5.94%, which was higher than the comparable margin of 4.59%. The international transactions were, therefore, at arm’s length.

Facts of the case

Manaksia Steels Limited was engaged in the manufacture of iron and steel products. For Assessment Year 2016-17, it filed its return declaring a total income of ₹10,55,26,530.

The case was selected for scrutiny under CASS on account of transfer-pricing risk parameters, as the assessee had entered into international transactions with its foreign associated enterprises.

The matter was referred to the Transfer Pricing Officer for determining the arm’s length price of transactions involving the sale of finished goods and purchase of raw materials from associated enterprises.

The assessee adopted the Transactional Net Margin Method, using operating profit to operating cost – OP/OC – as the Profit Level Indicator. There was no dispute regarding the selection of the comparable companies. The sole controversy concerned the manner in which depreciation was treated while computing the respective operating margins.

TPO’s computation

The Transfer Pricing Officer treated depreciation of ₹7,48,83,000 as part of the assessee’s operating expenditure. On this basis, the assessee’s operating figures were computed as follows:

• operating revenue: ₹289.33 crore;
• operating cost: ₹279.60 crore;
• operating profit: ₹9.73 crore; and
• OP/OC margin: 3.36%.

The arm’s length margin of the comparable companies was determined at 4.59%. Applying that margin to the assessee’s operating cost, the TPO calculated a revenue shortfall of ₹3.11 crore.

Since the transactions with associated enterprises constituted 36.66% of the assessee’s operating revenue, a proportionate transfer-pricing adjustment of ₹1,13,83,297 was proposed and added by the Assessing Officer.

CIT(A) confirms the adjustment

The assessee argued that the TPO had excluded depreciation from the operating expenditure of the comparable companies but included it in the assessee’s operating cost. This inconsistent treatment distorted the comparison.

The CIT(A), however, confirmed the adjustment. He observed that depreciation was ordinarily an operating expense and should form part of the operating cost under TNMM. According to the CIT(A), the assessee had failed to establish any difference in asset intensity, depreciation policy or capacity utilisation between itself and the comparables.

The CIT(A) characterised the exclusion of depreciation from the assessee’s operating cost as a selective adjustment that increased its margin from 3.36% to 5.94%.

Issue before the Tribunal

The issue was not whether depreciation is, in principle, an operating expenditure. The real question was whether the TPO could include depreciation while computing the assessee’s OP/OC margin but exclude it while computing the margins of the comparable companies.

The assessee contended that the same accounting and computational basis had to be adopted for both sides of the comparability analysis. If depreciation was excluded from the comparables, it had to be similarly excluded from the assessee’s operating cost.

ITAT’s findings

The Tribunal accepted the assessee’s contention. It observed that the TPO had adopted different standards:

• depreciation was included in the assessee’s operating expenditure; but
• depreciation was excluded from the operating expenditure of the comparable companies.

This resulted in an anomalous and fallacious comparison.

The Tribunal then recomputed the assessee’s margin by excluding depreciation of ₹7.49 crore from operating cost. The revised computation was:

• operating revenue: ₹289.33 crore;
• operating cost excluding depreciation: ₹272.11 crore;
• operating profit: ₹17.22 crore; and
• OP/OC margin: 5.94%.

Since the arm’s length margin of the comparables was only 4.59%, the assessee’s revised margin of 5.94% was higher. Applying the comparable margin to the operating cost excluding depreciation resulted in an arm’s length operating revenue of approximately ₹284.60 crore, whereas the assessee’s actual operating revenue was approximately ₹289.33 crore.

Thus, there was no shortfall requiring an adjustment.

Decision

The Tribunal held that the assessee’s international transactions were at arm’s length. It set aside the order of the CIT(A) and directed the Assessing Officer/Transfer Pricing Officer to delete the entire transfer-pricing adjustment of ₹1,13,83,297.

The assessee’s appeal was allowed in full.

Author’s comments

The decision should not be read as laying down a general rule that depreciation must invariably be excluded while computing the operating margin under TNMM. Ordinarily, depreciation may be regarded as an operating expense because it represents the allocation of the cost of assets employed in business.

The decisive factor in this case was consistency of treatment. A meaningful comparison cannot be made if depreciation is included in the tested party’s operating cost but excluded from the comparable companies’ cost base. Such asymmetrical treatment depresses the tested party’s margin and artificially creates a transfer-pricing adjustment.

The preferred approach is either to include depreciation consistently for both the assessee and the comparables or to exclude it consistently where reliable comparable depreciation data is unavailable or material differences warrant such treatment.

A suitable adjustment may also be required where the assessee and comparables have significantly different asset intensity, depreciation methods, useful lives, capacity utilisation or ownership models. However, the same computational principle must first be applied to both sides.

The ruling reinforces a basic transfer-pricing principle: comparability depends not merely on selecting comparable companies but also on computing their margins and the tested party’s margin on a uniform basis. A mathematically accurate calculation based on inconsistent components is not a reliable arm’s length analysis.

FULL TEXT OF THE JUDGMENT/ORDER OF ITAT, KOLKATA

1. This is an appeal preferred by the assessee against the order of the Commissioner of Income-tax (Appeals), Kolkata 22, (hereinafter referred to as the “Ld. CIT(A)”] dated 25.03.2026 for the AY 2016-17.

2. The only issue raised in ground no.1 is against the order of ld. CIT (A) confirming the addition made by the ld. AO/ Transfer Pricing Officer of ₹1,13,83,297/- on account of Arm’s Length adjustment of the international transactions entered into with the foreign Associated Enterprises.

3. The Facts in brief are that the assessee filed its return of income on 28.11.2016, declaring total income of ₹10,55,26,530/-. The case of the assessee was selected for scrutiny under Computer Assisted Scrutiny Selection (CASS) for the reason of the TP Risk Parameters as the assessee entered into international transactions with its AEs. The case of the assessee was referred to Transfer Pricing Officer for determination of Arm’s Length Price of international transactions. The Transfer Pricing Officer according Notice u/s 143(2) and 142(1) of the Act along with questionnaire were duly issued and served upon the assessee. The assessee also made the necessary compliances to the said notices. The assessee was engaged in the manufacturing of iron and steel products. The ld. Transfer Pricing Officer rejected the contention of the assessee that depreciation was always a part of operative expenditure and accordingly the PLI was determined at 3.36%. The assessee was following the Transactional Net Margin Method (TNMM) to benchmark the international transactions. So far as the comparable are concerned, there was no dispute as to the comparable which were considered by the ld. Transfer Pricing Officer for making Arm’s Length Price adjustments. However, the ld. Transfer Pricing Officer while computing the operating expenditure excluded the depreciation in respect of comparable but while computing the operating expenditure of the assessee, the depreciation was considered and accordingly the Arm’s Length of PLI (OP/OC) was determined at 4.59 and necessary adjustments were suggested by the ld. Transfer Pricing Officer as under:-

3.4 Determination of Arm’s Length Price:- On the basis of the above discussion, the arm’s length price of the sale of finished goods and purchase of raw material from Associated Enterprises and corresponding adjustment is worked out as under:-

4. Accordingly, the ld. AO made addition in respect of Arm’s Length Price adjustment of ₹1,13,83,297/- suggested by the TPO.

5. In the appellate proceedings, the ld. CIT (A) confirmed the order passed by the ld. AO/Transfer Pricing Officer on this issue by observing and holding as under:-

“I have duly examined the material at hand including the impugned order, the submissions of the appellant, the citations and orders relied upon by the appellant as well as the citations that are more broadly applicable to the facts of this case. The appeal thereafter is being disposed in a ground-wise manner as under:

Ground No.1, 2 &3:-These grounds of appeal are taken together. These grounds of appeal relate to the PLI (OP/OC) computed without reduction of depreciation, arm’s length PLI (OP/OC) computed by the appellant rejected, and the Addition of ALP adjustment of Rs. 1,13,83,297/-respectively.

The primary issue is that the inconsistency in the treatment of depreciation between the appellant and the comparable companies. The appellant submitted that TPO included depreciation in operating cost in its case but excluded in comparable and this created distortion.

Depreciation is an operating in nature. It must be included in OP/OC under TNMM therefore, TPO’s computations at 3.36% is correct.

The appellant’s contention that the depreciation excluded from the comparable cannot be accepted as no evidence has been filed. And secondly, financials of comparable (public) data) normally include depreciation. The appellant has not demonstrated factual inconsistency. By removing depreciation OC reduces and OP increases and the margin shows increase from 3.36% to 5.94%. This is a manipulation of PLI base and no a legitimate adjustment. The appellant has failed to show the difference in assets intensity, difference in depreciation policy and difference in capacity utilization of the comparable. The depreciation is integral part of operating cost unless exceptional circumstances are proved. The appellant has submitted for selective adjustment by removing depreciation from its own cost and re-working comparable without proper evidences. Such computation is not acceptable, Hence the action of the TPO is upheld and these grounds of appeal are dismissed.”

6. After hearing the rival contentions and perusing the materials available on record, we note from the record/documents placed before us that assessee has entered into international transactions with its foreign AE’s and followed TNMM method to benchmark its transactions with the AEs. We also note that so far as the comparable are concerned, there is no dispute but the only dispute is with regard to the methodology of computing the PLI (OP/OC). We note that the ld. AO has determined PLI (OP/OC) by excluding depreciation from the operating expenditure in the case of comparable but while computing the PLI in the case of the assessee the depreciation has been considered as part of operating expenditure. The ld. Transfer Pricing Officer determined the PLI at 4.9% in case of comparable while it was computed at 3.36% in case of the assessee. For the sake of ready reference, the Arm’s Length Price PLI (OP/OC) as computed by the Transfer Pricing Officer and the assessee are extracted below:-

–

6.1. Therefore, it is evident from the above that the profit margin as computed by the Transfer Pricing Officer after considering the depreciation as part of the expenses is 3.36% whereas without considering the deprecation as part of the operating expenses it is 5.94%. Therefore, the ld. Transfer Pricing Officer has committed an error in considering the depreciation as part of the operating cost in the case of the assessee and at the same time not considering the depreciation as part of operating cost in the case of comparable thereby making anomalous and fallacious comparison. If we calculate the Arm’s Length Price of the transactions without considering the depreciation as part of the operating cost, the same works different as under:

6.2. Considering the above facts, we note that the transactions in the case of the assessee are at Arm’s Length Price and no adjustment is to be made to the income of the assessee in respect of Arm’s Length Price of the international transactions with its AEs. Accordingly, we set aside the order of ld. CIT (A) and direct the ld. AO/ Transfer Pricing Officer to delete the addition of ₹1,13,83,297/-. The appeal of the assessee is allowed.

7. In the result, the appeal of the assessee is allowed.

Order pronounced on 11.09.2026.