The Hyderabad Bench of the Income Tax Appellate Tribunal (ITAT) has held that duly certified segmental financial results furnished by an assessee in transfer pricing documentation cannot be rejected mechanically or on an ad hoc basis merely because they do not mirror the segment disclosure in audited financial statements, particularly where the assessee has explained the basis of preparation, reconciled revenue, and allocated costs on identified and relevant cost drivers; in such circumstances, the TPO must independently examine the segmental results and cannot reallocate expenditure on turnover basis without investigation or without pointing out defects in the method adopted by the assessee.
The Tribunal further held that, in benchmarking interest on ECBs borrowed from an AE, the RBI-approved or RBI-permitted ceiling rate is a relevant factor for determining the arm’s length price, and where the interest paid by the assessee at LIBOR + 3% is within the RBI ceiling, the TPO is not justified in substituting the same with LIBOR + 2% on an ad hoc basis without undertaking the prescribed comparability analysis under Chapter X.
The Tribunal also held that outstanding receivables from AEs denominated in foreign currency constitute a separate international transaction, and the arm’s length interest thereon is to be computed at LIBOR + 200 basis points on an invoice-to-invoice basis in accordance with the Tribunal’s earlier order in the assessee’s own case.
The Division Bench comprising Ravish Sood (Judicial Member) and Manjunatha G. (Accountant Member) on the issue of segmental financials, found merit in the assessee’s contention that the TPO had summarily rejected the segmental financial information furnished in the TP documentation, though the same was certified by a Cost and Management Accountant and based on direct identification of costs and relevant allocation keys such as FTE hours, machine hours, and turnover for limited expenses.
The Tribunal observed that the TPO rejected the segmental results only because the audited financials did not match the segment results, even though the assessee had explained that the TP segmental results were business-segment-wise with AE and non-AE bifurcation, whereas the audited financials followed AS-17 and reflected only related party and non-related party details without business-segment-wise segregation.
The Tribunal further observed that the revenue from operations in the audited financials and in the TP documentation was duly reconciled, and that the TPO had proceeded on a wrong premise by overlooking the assessee’s detailed reply. It also accepted the assessee’s objection that allocation of costs on a revenue proportion basis would result in the same profitability for all segments, thereby incorrectly equating AE and non-AE segments.
The assessee had prepared segmental financials to provide a more accurate profitability analysis, with directly identifiable segment revenue and costs, and allocation of residual costs on relevant keys, resulting in segmental operating margins of 15.44% for contract R&D services and 17.26% for manufacturing of API, noted the Tribunal.
The Tribunal held that where expenses are allocated on jointly accepted accountancy principles, identified cost drivers, and a prudent basis, the AO/TPO/DRP are not justified in reallocating expenditure in the ratio of turnover without investigation, without collecting material, and without pointing out discrepancies in the assessee’s method. On that basis, the Tribunal held that the TPO and DRP had mechanically rejected the duly certified segmental results without independent analysis.
On the adjustment relating to interest on ECBs, the Tribunal observed that the assessee had benchmarked the interest on ECBs denominated in USD at LIBOR + 3%, but the TPO had summarily substituted the same with LIBOR + 2% without carrying out any proper comparability benchmarking under Chapter X. The Tribunal accepted the assessee’s contention that since the loan from the AE had been obtained with prior RBI approval and the rate of LIBOR + 3% was below the ceiling prescribed by RBI, the transaction could be regarded as being at arm’s length. Additionally, the Tribunal reiterated that the RBI-approved or RBI-permitted rate is a relevant benchmark for ECB interest and that LIBOR + 3% was at arm’s length.
On outstanding trade receivables, the Tribunal did not accept the assessee’s argument that such receivables were not an international transaction. However, it held that the issue was covered by the Tribunal’s own earlier order in the assessee’s case for AYs 2010-11 to 2014-15, where it had been held that outstanding receivables from AEs in foreign currency constituted a separate international transaction and interest was to be imputed at LIBOR + 200 basis points. The Tribunal reiterated that such computation should be made on an invoice-to-invoice basis so that the actual delay period in respect of each invoice could be worked out, and accordingly directed the AO/TPO to recompute the ALP of interest on outstanding receivables following the earlier order.
On brought forward losses, the Tribunal noted the assessee’s claim that, pursuant to amalgamation of AMRI India and Finekem India with the assessee, losses of the amalgamating companies had been taken over, that Form 62 had been filed, and that the conditions of Section 72A had been satisfied. However, since adjudication of the issue required verification of facts, and the DRP had already directed the AO to verify the record and allow the claim in accordance with law, the Tribunal found no infirmity in the DRP’s direction and upheld the same.
Briefly, the appellant, a wholly owned subsidiary of the Curia Group, set up to provide R&D services in the field of medicinal chemistry to its associated enterprises, had filed its return declaring nil income. Upon reference under Section 92CA(1) of the Income-tax Act, for determination of the arm’s length price of the international transactions reported in Form 3CEB, the TPO proposed a total transfer pricing adjustment of Rs. 8.15 Crores comprising adjustment towards contract research and development services, contract manufacturing services, interest on external commercial borrowings, reimbursement of expenses received from AEs, and interest on outstanding receivables.
Based on the TPO’s order, the AO passed a draft assessment order under Sections 143(3) read with 144C, and the DRP largely upheld the adjustments, while granting partial relief only in relation to reimbursement of expenses by directing adoption of a 5% markup on reimbursement cost. Thereafter, the AO, pursuant to the DRP’s directions, reduced the TP adjustment to Rs. 8.10 Crores and passed the final order under Sections 143(3) read with 144C(13), determining total income at Rs. 7.49 Crores.
The appellant challenged the rejection of certified segmental financial information, the substitution of the ECB interest benchmarking from LIBOR + 3% to LIBOR + 2%, the adjustment on outstanding receivables from AEs, and the non-adjustment of brought forward losses of Rs. 116.62 Crores said to have been taken over pursuant to amalgamation of AMRI India and Finekem India, in respect of which Form 62 had been filed under Section 72A.
Cases Relied On:
Principal Commissioner of Income Tax v. Nalwa Steel & Power Limited – ITA 725/2019
TPSC (India) (P.) Ltd. v. DCIT – (2024) 160 taxmann.com 693 (Hyderabad)
CIT v. GE India Technology Center Pvt Ltd – ITA No. 282 of 2013
Firemenich Aromatics (India) Pvt Ltd. vs ACIT – ITA No.7844/Mum/2019
Goodyear South Asia Tyres Private Limited vs ACIT – ITA No.7715/Mum/2012
Firestone International Pvt Ltd. vs ACIT – ITA No. 5471/Mum/2014
Appearances:
Advocate Ananya Kapoor, for Appellant/ Taxpayer
Dr. Narendra Kumar Naik, CIT-DR, for Respondent/ Revenue
