ITAT Bangalore Confirms TP Adjustment Restricted to AE Transactions in DCIT Vs Brady Company India Private Limited
Background of the Dispute
The Bangalore Bench of the Income Tax Appellate Tribunal in DCIT Vs Brady Company India Private Limited examined the scope of transfer pricing (TP) adjustments in respect of international transactions with Associated Enterprises (AEs). The central controversy was whether the arm’s length price (ALP) adjustment determined under the Transactional Net Margin Method (TNMM) for the manufacturing segment could validly be applied to the assessee’s entire segmental results or had to be confined strictly to international transactions with AEs.
The Deputy Commissioner of Income Tax had challenged the appellate order of the Commissioner of Income Tax (Appeals) [CIT(A)] for assessment year 2010-11, which had effectively led to a complete deletion of a TP adjustment of Rs. 2,95,99,030 initially made for the manufacturing segment.
The Tribunal ultimately upheld the directions of the CIT(A), dismissed all grounds raised by the Revenue, and reaffirmed the principle that TP adjustments under Chapter X of the Income Tax Act, 1961 must be restricted to international transactions with AEs alone.
Profile of the Assessee and Nature of Operations
Brady Company India Private Limited, incorporated on 7 March 2006 as a private limited company, was engaged in three distinct lines of business:
Manufacturing segment –
- Production of identification solutions, including high-performance electronic trackers and die-cut products.
- The manufacturing unit functioned as an export-oriented unit.
Shared services / IT-enabled services segment –
- A unit registered under the Software Technology Park of India scheme, commencing operations in October 2006.
- Rendering business process outsourcing (BPO) and information technology enabled services in areas such as:
- Accounting
- Information technology support
- Procurement and allied back-office functions
- Acting as a centralised hub for accounting and related services to group entities worldwide.
Trading segment –
- Import of finished goods from AEs.
- Resale of such products in the domestic market.
For the relevant year, the assessee filed a return of income on 15 October 2010, declaring NIL income after claiming deduction of Rs. 2,18,44,872 under Section 10A. The case was selected for scrutiny, and due to the existence of international transactions, a reference was made to the Transfer Pricing Officer (TPO) under Section 92CA.
Transfer Pricing Examination and Initial Adjustment
Segment-wise Profitability and TP Study
The assessee had reported separate segmental results and margins as under:
- Manufacturing segment – negative margin of
-2.27% - Trading segment – positive margin of
16.98% - Shared services segment – positive margin of
21.48%
For each of these segments, the assessee had selected comparables using multiple-year data and applied TNMM as the most appropriate method.
The TPO, after examining the filters and comparables used in the TP documentation, rejected the assessee’s TP study on the grounds that:
- Certain filters were not properly applied, and
- Selected comparables did not meet the functional, asset, and risk (FAR) profile required.
For the manufacturing segment, the TPO selected 10 comparables (including some originally chosen by the assessee), and determined the margins as follows:
- Mean margin of comparables on
OP/OC– 7.32% - Mean margin of comparables on
OP/Sales (OP/OR)– 6.40%
Applying the TNMM at the segment level, the TPO computed the ALP on the basis of operating revenue of Rs. 33,92,74,880 and determined that the arm’s length operating cost should have been Rs. 31,75,61,288, while the assessee’s actual operating cost was Rs. 34,71,60,318.
This led to a proposed TP adjustment of Rs. 2,95,99,030 in respect of the manufacturing segment.
The Assessing Officer (AO) passed the assessment order under Section 143(3) read with Section 144C on 22 April 2014, incorporating this TP adjustment and making certain other disallowances under the normal provisions. However, the assessed income still remained at Rs. NIL due to the availability of deduction.
Findings and Directions of the CIT(A)
The assessee filed an appeal before the CIT(A), who passed an order dated 10 October 2014 granting significant relief. The key directions were:
1. Restriction of TP Adjustment to AE Transactions
The CIT(A) directed that the TP adjustment in the manufacturing segment must be computed only with respect to international transactions with AEs, and not with reference to the entire segment turnover or costs, which would include non-AE dealings.