ITAT Bangalore Clarifies TP Comparables for Trading-Focused Assessee and Validates IT Support Charges

Background of the Dispute

The Bangalore Bench of the Income Tax Appellate Tribunal, in the case of DCIT Vs 3M India Limited, resolved two transfer pricing controversies concerning Assessment Years 2008-09 and 2009-10. The matters were heard together and decided by a consolidated order, as both years involved the same assessee, identical business model, and overlapping transfer pricing issues.

The assessee, 3M India Limited, is engaged in manufacture, conversion, and trading of a wide range of products. For income-tax purposes, it maintains segmental accounts for six distinct business segments, including a healthcare market segment, which became the core focus of the transfer pricing dispute.

The Revenue’s appeals before the Tribunal centred on:

  1. Selection and exclusion of comparables for benchmarking the healthcare segment under the Transactional Net Margin Method (TNMM), particularly where the assessee is predominantly a trader and certain comparables are mainly manufacturers; and
  2. Transfer pricing adjustment on IT support services, where the Transfer Pricing Officer (TPO) determined the arm’s length price (ALP) of certain intra-group IT-related payments at nil.

The Tribunal ultimately dismissed the Revenue’s appeals for both years, thereby affirming the findings of the Commissioner of Income Tax (Appeals) [CIT(A)].

Business Profile and Segmental Results

Nature of Activities

The assessee operates in India in the fields of:

  • Manufacturing of certain products,
  • Conversion activities, and
  • Trading in a large portfolio of goods.

For the relevant years, the assessee reported overall margins in its financial statements as follows:

  • Operating profit to operating cost (OP/OC): 18.68%
  • Operating profit to revenue (OP/Sales): 15.74%

The assessee also prepared segmental accounts for six business segments:

  1. Industrial market
  2. Automotive and specialty material market
  3. Traffic and safety market
  4. Office equipment and construction market
  5. Healthcare market
  6. Consumer market

Each segment had different profitability levels, but the dispute concerned only the healthcare market segment.

Healthcare Segment Margins

For the healthcare segment, the assessee declared:

  • Operating profit to cost (OP/OC): 2.99%
  • Operating profit to sales (OP/Sales): 2.90%

Under TNMM, the assessee selected five comparable companies and arrived at an arithmetic mean margin of 2.8% on sales, contending that its healthcare-related international transactions were at arm’s length.

TPO’s Approach and Transfer Pricing Adjustment

Rejection of Assessee’s TP Study

The TPO discarded the assessee’s transfer pricing documentation and conducted a fresh search using the Prowess and Capitaline databases. After his own analysis, the TPO identified six comparable companies and computed:

  • Arithmetic mean margin on sales: 14.55% (subsequently worked out to 12.22% OP/Sales and 17.10% OP/OC in the final computation).

Based on these comparables, the TPO determined an arm’s length operating revenue of Rs. 76,16,35,459/- for the healthcare segment, against an actual operating cost of Rs. 84,24,94,000/-.

This exercise led to a transfer pricing adjustment of Rs. 8,08,58,541/- under Section 92CA for Assessment Year 2008-09. The total transfer pricing adjustment, including other items, contributed significantly to the addition in the assessment order under Section 143(3) r.w.s. Section 144C.

Assessee’s Objections before TPO

The assessee argued that:

  • Its healthcare segment is overwhelmingly trading-oriented.
  • 93.1% of its healthcare revenue arises from trading activities.
  • Only 6.7% of revenue is attributable to conversion (manufacturing-type) activities.
  • Several of the TPO’s comparables were predominantly or exclusively manufacturing companies, making them functionally incomparable.
  • Segmental data for certain comparables were unavailable, which further vitiated any meaningful comparison.
  • A working capital adjustment should be provided.

The TPO nevertheless persisted with his selection of six comparables and the resultant margins, rejecting the assessee’s plea to remove manufacturing-dominant entities from the sample.

Findings of CIT(A) on Comparables

Characterisation of Assessee as Predominantly Trader

Before the CIT(A), the assessee emphasised that, within the healthcare segment:

  • Trading constituted 93.1% of total sales; and
  • Conversion activities constituted only 6.7%.