ITAT Delhi on Transfer Pricing Comparables and Interest on Receivables in Bechtel India India Pvt. Ltd. Vs ACIT

Overview of the Case

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) delivered an important ruling in the matter of Bechtel India India Pvt. Ltd. Vs ACIT concerning Assessment Year 2013-14. The appeal primarily revolved around two distinct transfer pricing (TP) issues:

  1. Adjustment proposed on the international transaction relating to engineering design and related services; and
  2. Adjustment on account of interest alleged to be chargeable on outstanding receivables from Associated Enterprises (AEs).

The assessee, a wholly owned subsidiary of Bechtel Corporation USA, challenged:

  • Selection and inclusion of certain comparable companies;
  • Rejection of its segmental allocation approach;
  • Treatment of foreign exchange gains/losses as non-operating;
  • Denial and computation of working capital adjustment; and
  • Separate TP adjustment on delayed realization of receivables treated as a financing transaction.

The Tribunal partly allowed the appeal, granting substantial relief to the assessee on both major issues.

Background Facts

Assessee’s Business and International Transactions

The assessee company was incorporated on 21/04/1994 as a captive service provider to its foreign AEs. Its primary activities included:

  • Preparation of engineering designs and drawings for projects executed by its AEs;
  • Financial and accounting support services;
  • Information technology infrastructure support services; and
  • Certain reimbursement arrangements.

For the year under consideration, the assessee filed its return of income on 12/11/2013 declaring a total income of ₹ 49,63,12,880/-. The case was selected for scrutiny and, in light of international transactions, was referred to the Transfer Pricing Officer (TPO) under Section 92 of the Income Tax Act 1961.

Segments and Economic Analysis

The assessee benchmarked its international transactions using the Transactional Net Margin Method (TNMM) with Operating profit / Operating cost (OP/OC) as the Profit Level Indicator (PLI). The key segments and margins were as under:

  • Engineering design and related services

    • Value: ₹ 241.96 crores
    • Method: TNMM
    • Assessee’s margin (OP/OC): 14.00%
    • Mean margin of comparables in TP study: 13.87%
    • Updated mean margin of comparables (by assessee): 10.02%

  • Financial and accounting support services

    • Value: ₹ 8.94 crores
    • Method: TNMM
    • Assessee’s margin: 17.7%
    • Mean margin of comparables (updated): 12.59%

  • Information technology infrastructure support services

    • Value: ₹ 27.44 crores
    • Method: TNMM
    • Assessee’s margin: 18.8%
    • Mean margin of comparables: 11.88% (updated: -2.26%)

  • Reimbursement of expenses (paid) – ₹ 4.21 crores

  • Reimbursement of expenses (received) – ₹ 20.55 crores (benchmarked under Comparable Uncontrolled Price Method).

The transfer pricing dispute in this appeal substantially centered on the engineering design and related services segment and a separate notional interest adjustment on receivables.

Functional Profile of the Assessee (FAR Analysis)

The TPO recorded a detailed Functions, Assets and Risks (FAR) analysis. Salient points included:

  • The AEs secured engineering projects from end customers and allocated work related to engineering design, drawing and associated activities to the assessee.
  • The assessee employed specialized engineers in plant layout, civil, mechanical, piping, electrical, instrumentation and process design, among others.
  • The assessee maintained Wide Area Network (WAN) leased lines to integrate its IT systems with those of its AEs.
  • Designs and drawings were prepared using engineering software and transmitted electronically to AEs.
  • Multiple internal divisions such as design & piping, civil structure, electrical, controls, mechanical and process worked in an integrated project-based model.
  • Besides design work, the assessee also supported AEs in procurement and construction support related activities.

This profile was crucial in testing functional comparability of proposed comparable companies.

TPO’s Adjustments and DRP Directions

While computing the assessee’s margin, the assessee had not routed reimbursement of expenses received (₹ 20,55,04,985/-) through its Profit and Loss account. The TPO considered these reimbursements as part of operating income and recomputed OP/OC at 11.45% instead of 14%.

The TPO further:

  • Applied additional filters for selection of comparables;
  • Ultimately included 11 companies in the final set;
  • Arrived at a mean PLI of 25.09% for comparables; and
  • Proposed a TP adjustment of ₹ 27,32,88,151/- on the engineering design segment.

The Dispute Resolution Panel (DRP):

  • Directed exclusion of Holtec Consulting Private Limited following earlier ITAT orders in the assessee’s own case;
  • Ordered the TPO to:
    • Grant working capital adjustment;
    • Treat foreign exchange gain/loss as operating items; and
    • Correct margins of selected comparables where necessary.

Pursuant to DRP’s directions, the TPO passed a rectification order dated 20/12/2017 and recomputed margins as under (working capital adjusted OP/OC):