Transfer pricing adjustments apply strictly to associated enterprise dealings, with profit margins determined by operational items.

ORDER

Sandeep Singh Karhai, Judicial Member. – The assessee has filed the present appeal against the impugned final assessment order dated 23.12.2025, passed under section 143(3) r.w.s 144C(13) r.w.s. 144B of the Income-tax Act, 1961 (“the Act”), pursuant to the directions dated 27.11.2025 issued by the learned Dispute Resolution Panel-2, Bengaluru [“learned DRP”], for the assessment year 2022-23.

2. The brief facts of the case are that the assessee is a private limited company and, for the year under consideration, filed its return of income on 26.02.2022, declaring a total income of Rs. NIL. The return filed by the assessee was selected for scrutiny, and a statutory notice under section 143(2) of the Act was issued and served on the assessee. Since the assessee has entered into large value international transactions with its associated enterprises, reference under section 92CA(1) of the Act was made to the Transfer Pricing Officer (“TPO”) for determination of arm’s length price of the international transactions entered into by the assessee. After considering the submissions filed by the assessee, the TPO, vide order dated 11.01.2025 passed under section 92CA(3) of the Act, made a total transfer pricing adjustment of Rs. 4,59,72,570/-, as follows: –

3. In conformity, the Assessing Officer (“AO”) passed the draft assessment order dated 06.02.2025 under section 144C(1) of the Act, incorporating the transfer pricing adjustment proposed by the TPO. The learned DRP, vide its directions issued under section 144C(5) of the Act, inter alia, rejected the objections filed by the assessee. In conformity with the directions issued by the learned DRP, the AO passed the impugned final assessment order on 23.12.2025 under section 143(3) r.w.s 144C(13) r.w.s. 144B of the Act.

4. Being aggrieved, the assessee has raised the following grounds: –

5. Ground No. 1 is general in nature. Therefore, the same needs no separate adjudication.

6. Ground No. 2, raised in the assessee’s appeal, pertains to restricting the transfer pricing adjustment to the transactions entered into with the associated enterprises.

7. During the hearing, the learned Authorised Representative (“learned AR”) submitted that the transfer pricing adjustment was made considering the entire transaction of the assessee, which primarily relates to the transaction with unrelated parties. The learned AR submitted that during the year under consideration, the assessee entered into various transactions with its associated enterprises and non-associated enterprises. The learned AR submitted that, out of the total sales of Rs. 79.28 crores, the turnover from the associated enterprises is only Rs. 13.41 crores, and the remaining sales of Rs. 65.87 crores are from non-associated enterprises. Thus, the learned AR submitted that the transfer pricing adjustment cannot be computed at the entity level and the same needs to be restricted to the international transactions undertaken by the assessee with its associated enterprises. On the other hand, the learned Departmental Representative (“learned DR”) vehemently relied upon the order passed by the lower authorities on this issue.

8. Having considered the submissions of both sides and perused the material available on record, we find that the Hon’ble Bombay High Court in CIT v. Thyssen Krupp Industries India (P.) Ltd. 381 ITR 413 (Bom) held that the adjustment which is mandated in terms of Chapter – X is only in respect of the international transaction and not the transactions entered into by the assessee with independent unrelated third parties. The relevant findings of the Hon’ble Bombay High Court in the aforesaid decision are reproduced as follows: –

“We find that in terms of Chapter X of the Act, re-determination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transaction and not transactions entered into by assessee with independent unrelated third parties. This is particularly so as there is no issue of avoidance of tax requiring adjustment in the valuation in respect of transactions entered into with independent third parties. The adjustment as proposed by the Revenue if allowed would result in increasing the profit in respect of transactions entered into with non-AE. This adjustment is beyond the scope and ambit of Chapter X of the Act.”

9. We find that the Hon’ble Bombay High Court also concurred with the view taken by the Hon’ble Delhi High Court in CIT v. Keihin Panalfa Ltd. 381 ITR 407 (Delhi). Accordingly, respectfully following the aforesaid decisions, we direct the AO/TPO to restrict the transfer pricing adjustment, if any, to the international transactions entered into by the assessee with its associated enterprises. As a result, Ground No. 2 raised in assessee’s appeal is allowed.

10. Ground No. 3, raised in assessee’s appeal, pertains to considering certain expenses like marketing and promotional expenses, provision for warranty and bad debts written off as operating expenses by the TPO.

11. During the hearing, the learned AR submitted that the learned DRP, vide its directions, specifically directed that marketing and promotional expenses, provision for warranty and bad debts written off be considered as non-operating expenses while computing the operating margin of the assessee and comparables. However, the TPO, while giving effect to the directions of the learned DRP, retained the same margin computation as done vide order passed under section 92CA(3) of the Act. The learned AR submitted that in this regard, the assessee has already filed a rectification application which is currently pending disposal.

12. We find that vide its directions dated 27.11.2025, the learned DRP, inter alia, issued the following directions: –

“4.1 Panel: Having considered the submission of the assessee, we discuss this ground of objection in the following paragraphs:-

4.1.1 Marketing and promotional expenses:- The taxpayer has claimed that marketing and promotional expenses relates to Non-AE sales. TPO is directed to treat the same as non-operating for the purpose of PLI computation if it has been established that the same relates only to Non-AE sales from robust audited segmental reports maintained by the assessee. Ground adjudicated accordingly.

4.1.2 Provisions for warranty expenses- A provision reflects a possible future obligation, dependent on uncertain events or pending confirmation of liability. Under transfer pricing principles, contingent or uncrystallized liabilities do not qualify as operating expenses because they do not reflect actual resources consumed in the relevant financial year for carrying out business operations. Inclusion of such contingent provisions in operating costs would distort the computation of the profit margin and defeat the comparability analysis under the TNMM.

In view of the above, TPO is directed to exclude such provision in margin computation of both assessee and comparable. Ground allowed.

4.1.3. Bad debts written off :- The assessee submitted that the bad debts written off were considered as non-operating item. This Panel has been consistently holding that bad debts written off cannot be considered as operating expense. They are not the expenses incurred in earning the current year operating revenue. Besides, the bad debts related to income already admitted as revenue in the earlier year/years and is in no way related to the operating revenue earned during the year, and hence cannot be taken into account in determining the operating profit for the year. The bad debts written is only an accounting treatment, and have no direct nexus to the operating income admitted for the year. Hence, this Panel is of the view bad debts written off are non-operating expense. Therefore, TPO is directed to exclude the same in margin computation for both the assessee and the comparable. Ground allowed.”

13. Therefore, we direct the TPO to comply with the directions issued by the learned DRP and re-compute the operating margin of the assessee in terms of the aforenoted directions issued by the learned DRP. As a result, Ground No. 3 raised in assessee’s appeal is allowed for statistical purposes.

14. Ground No. 4, raised in assessee’s appeal, pertains to considering the liabilities written back as operating revenue.

15. During the hearing, the learned AR submitted that during the year under consideration, the assessee has written back the liabilities/provisions no longer required amounting to Rs. 7,07,857/-. The learned AR submitted that the liabilities written back are of an operating nature and hence should be included in the computation of operating revenue of the assessee. On the other hand, the learned DR vehemently relied upon the directions issued by the learned DRP on this issue.

16. We have considered the submissions of both sides and perused the material available on record. The learned DRP, vide its directions, held that the provisions written back are not an item of revenue relating to the operations for the year under consideration and therefore cannot be considered for computing the operating revenue of the assessee. On the other hand, as per the assessee, the liabilities, which are written back, form part of the operating cost, and therefore, any write-off thereof should be considered as operating revenue since the basic nature of the same is operating, as it was incurred in the regular course of the operating activities of the assessee. We find that the Hon’ble Bombay High Court in Pr. CIT v. Tetra Pak India (P.) Ltd.  (Bom) held that the liabilities belonging to earlier years, which are no longer payable to the business creditors, and therefore, are written back in the year under consideration arises out of the normal business operations and should form part of the operating income. Thus, respectfully following the decision of the Hon’ble Bombay High Court, we direct the TPO to consider the liability/provisions no longer required written back as operating in nature while computing the margins of the assessee. As a result, Ground No. 4 raised in assessee’s appeal is allowed.

17. Ground No. 5, raised in assessee’s appeal, pertains to considering export incentive as operating income for computing the margins of the assessee.

18. During the hearing, the learned AR submitted that the assessee in its objections before the learned DRP submitted that the TPO made an error in computing the operating income of the assessee and instead of adding “Other Operating Income” to “Total Revenue”, reduced the same from the “Total Revenue”, thus computing the operating income of the assessee at Rs. 79,47,21,520/-. The learned AR submitted that the learned DRP, instead of correcting the computational error made by the TPO, affirmed the findings of the TPO on the basis that the “Other Operating Income” represents export incentive, which is in the nature of non-operating income. The learned AR submitted that the export incentives are directly linked to the assessee’s export sales and, therefore, are in the nature of operating income. In support of her contention, the learned AR placed reliance upon various judicial pronouncements. On the other hand, the learned DR vehemently relied upon the findings of the learned DRP on this issue.

19. Having considered the submissions of both sides and perused the materials available on record, we find that during the year under consideration the assessee received export incentives of Rs. 19,90,710/-. From the perusal of the record, we further find that during the year under consideration, the assessee declared total export sales of Air Handling Units manufactured by it of Rs.13,47,09,300/-. Thus, it is evident that the export incentives received by the assessee were on account of the export sales made by the assessee during the year under consideration. We find that the Hon’ble Bombay High Court in CIT v. Welspun Zucchi Textiles Ltd [2017]  391 ITR 211 (Bom) held that the export incentives are operating in nature. Accordingly, respectfully following the decision of the Hon’ble Bombay High Court cited supra, we direct the TPO to consider export incentives as part of operating revenue for the purpose of computing the operating margin of the assessee. As a result, Ground No. 5 raised in assessee’s appeal is allowed.

20. Ground No. 6, raised in assessee’s appeal, pertains to the error in computation of operating income of the assessee.

21. During the hearing, the learned AR submitted that the TPO made an error in computing the operating income of the assessee by reducing “Other Operating Income” of Rs. 19,90,710/- from “Total Revenue”, thus computing the operating income of the assessee at Rs. 79,47,21,520/-. By referring to the profit and loss account of the assessee, the learned AR submitted that the “Other Operating Income” of Rs. 19,90,710/- was a separate line-item from the “Total Revenue” from operations of the assessee for the year under consideration of Rs. 79,67,12,230/-. Thus, the learned AR submitted that the reduction of “Other Operating Income” from “Total Revenue” has resulted in double exclusion of the same income.

22. Having considered the submissions of both sides and perused the materials available on record, we find that vide its directions issued under section 144C(5) of the Act, the learned DRP merely upheld exclusion of Rs.19,90,710/- from the operating income of the assessee on the basis that the said amount represents export incentive, which is in the nature of nonoperating income. Thus, it is evident that there was no direction of the learned DRP to exclude “Other Operating Income” from the “Total Revenue”. Accordingly, we find merit in the submissions of the assessee. As we have already directed the AO/TPO to consider export incentives as part of operating revenue, we are of the considered view that the “Total Revenue” of the assessee be considered at Rs. 79,67,12,230/- as declared by the assessee in its financial statements. As a result, Ground No. 6, raised in the assessee’s appeal, is allowed.

23. The issue arising in Grounds No. 7 – 12, raised in assessee’s appeal, pertains to the transfer pricing adjustment in relation to international transaction of “sale of finished goods”.

24. The brief facts of this case pertaining to this issue, as emanating from the record, are: During the year under consideration, the assessee entered into the following international transactions with associated enterprises: –

25. Since the international transactions of purchase of goods – raw materials, purchase of capital goods, services availed from associated enterprise – royalty paid and professional fees paid were closely linked with the international transaction of “sale of finished goods”, the assessee aggregated the said international transactions with the international transaction of “sale of finished goods” and benchmarked by adopting Transactional Net Margin Method (“TNMM”) as the most appropriate method with the Profit Level Indicator (“PLI”) of Operating Profit to Operating Cost (“OP/OC”). By considering itself the tested party, the assessee identified three companies as comparable. As the assessee’s operating margin at 3.99% was within the tolerance range of +/-3% of the arithmetic mean of the operating margin of the comparable companies at 5.28%, the assessee claimed the international transaction of “sale of finished goods” is at arm’s length price.

26. During the transfer pricing assessment proceedings, the TPO, by applying additional filters, arrived at a final set of 12 companies as comparables for benchmarking the international transaction of “sale of finished goods”. Since the 35^th to 65^th percentile range of 12 companies considered as comparable by the TPO ranged between 6.79% to 9.11%, with a median of 8.56%, the TPO by applying the arm’s length margin proposed an adjustment of Rs. 4,55,15,196/- in respect of international transaction of “sale of finished goods”, vide order dated 11.01.2025 passed under section 92CA(3) of the Act.

27. The learned DRP, vide its directions dated 27.11.2025, partially agreed with the objections filed by the assessee and directed the exclusion of one company as comparable, which was included by the TPO while benchmarking the international transaction of sale of finished goods. The final set of comparable companies, pursuant to the directions issued by the learned DRP, is as follows: –

28. In conformity with the directions issued by the learned DRP, the AO passed the impugned final assessment order, inter alia, incorporating the transfer pricing adjustment on account of international transaction of “sale of finished goods” of Rs. 4,35,02,837/-.

29. During the hearing, the learned AR submitted that if six companies, namely, Frick India Limited, Voltas Limited, Daikin Airconditioning India Private Limited, Rockwell Industries Limited, Western Refrigeration Private Limited and Sidwal Refrigeration Industries Private Limited are directed to be excluded, then this international transaction shall be at arm’s length and the entire transfer pricing adjustment made in respect thereof shall be deleted.

30. Accordingly, in view of the submissions made by the learned AR, we have confined our findings only in respect of the aforementioned companies which are sought to be excluded by the assessee.

31. We have considered the oral/written submissions of both sides and perused the materials available on record.

32. Before proceeding further, it is relevant to note the functions performed by the assessee in relation to the international transaction of “sale of finished goods”. From the record, it is evident that the assessee is engaged in manufacturing all kinds of Air Handling Units, providing related consultancy, advisory, and engineering services to its customers, and trading in all kinds of Air Handling Units. For manufacturing the Air Handling Units, which are also sold to the associated enterprises, the assessee purchases the accessories and raw materials from its associated enterprises.

33. The comparative functions performed by the assessee and its associated enterprises in respect of manufacturing and sale of Air Handling Units, as tabulated in the Transfer Pricing Study Report, are as follows: –

34. Explaining the functionality of Air Handling Units, manufactured by the assessee, the learned AR during the hearing submitted that an Air Handling Unit is a device used to regulate and circulate air as part of a heating, ventilating and air-conditioning system. It was submitted that Air Handling Unit is an intermediary product which goes into the end products sold by the companies, which are selected by the TPO as comparables. The learned AR submitted that the Air Handling Unit is not the final product.

35. Having noted the functions performed by the assessee in respect of the international transaction of “sale of finished goods”, we shall now deal with the companies sought to be excluded as comparable by the assessee for benchmarking the aforesaid international transaction.

36. The first company sought to be excluded by the assessee is Frick India Limited. This company was considered as comparable by the TPO, vide order passed under section 92CA(3) of the Act, on the basis that this company is functionally comparable to the assessee. The learned DRP, vide its directions, rejected the objections filed by the assessee and affirmed the findings of the TPO in considering this company as comparable to the assessee. Being aggrieved, the assessee has sought exclusion of this company for benchmarking the international transaction of “sale of finished goods”.

37. During the hearing, the learned AR submitted that Frick India Limited is not functionally comparable to the assessee as it provides a wide range of products. In support of this contention, the learned AR relied upon the relevant extracts of the Annual Report of Frick India Limited. On the other hand, the learned DR vehemently relied upon the order passed by the lower authorities in respect of this company.

38. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Annual Report of Frick India Limited, forming part of Paper Book Vol-4 from pages 189-191, we find that the company claims to be the largest equipment manufacturer and turnkey solution provider for industrial refrigeration in India. Further, it is stated that this company is engaged in manufacturing industrial refrigeration and air-conditioning equipment. The various products manufactured by this company, as provided in its Annual Report, are as follows: –

39. Therefore, from the perusal of the aforesaid details of products manufactured by this company, we find that it is also engaged in manufacturing air-conditioning and refrigeration equipment, which are only intermediate products and not the final products. During the hearing, the learned AR submitted that this company provides a wide range of products, unlike the assessee, which manufactures only Air Handling Units. However, we are of the considered view that the wide range of products manufactured by this company by itself cannot lead to the conclusion that it is not functionally comparable to the assessee, as all these products are industrial refrigeration and air-conditioning equipments, and the assessee is also manufacturing the air-conditioning and refrigeration equipment, such as modular air handling units, duct air handling and conditioning systems, as noted in the TPO’s order. Thus, it is evident that both the assessee and Frick India Limited are in the same business segment of manufacturing airconditioning and refrigeration equipments. Accordingly, we are of the considered view that Frick India Limited is functionally comparable to the assessee and has been correctly considered comparable for benchmarking the international transaction of “sale of finished goods” by the AO/TPO. Accordingly, the order passed by the lower authorities in respect of this company is upheld.

40. The next company sought to be excluded by the assessee is Voltas Limited. This company was considered as comparable by the TPO, vide order passed under section 92CA(3) of the Act, on the basis that it is functionally comparable to the assessee as it is engaged in manufacturing air-conditioners, refrigeration products and systems, etc. The learned DRP, vide its directions, rejected the objections filed by the assessee and affirmed the findings of the TPO in considering this company as comparable to the assessee. Being aggrieved, the assessee has sought exclusion of this company for benchmarking the international transaction of “sale of finished goods”.

41. During the hearing, the learned AR submitted that Voltas Limited is a large air-conditioning company and offers a range of cooling and home appliances, including air-conditioners, coolers, air purifiers, refrigerators, washing machines, etc. Thus, it was submitted that this company is not functionally comparable to the assessee, as the assessee does not manufacture any of these products. On the other hand, the learned DR vehemently relied upon the order passed by the lower authorities in respect of this company.

42. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Annual Report of Voltas Limited forming part of the Paper Book Vol-4 from pages 192-211, we find that this company offers room air-conditioners, air coolers, freezers, visi coolers, water dispensers, variable refrigerant flow, cassette airconditioners, chillers, Tower air-conditioners, washing machines, microwaves, dishwashers, etc. Therefore, having perused the details provided in the Annual Report, we are of the considered view that Voltas Ltd cannot be said to be comparable to the assessee. Accordingly, we direct the AO/TPO to exclude Voltas Limited for benchmarking the international transaction of “sale of finished goods”.

43. The next company sought to be excluded by the assessee is Daikin Airconditioning India Private Limited. This company was considered as comparable by the TPO, vide order passed under section 92CA(3) of the Act, on the basis that it is functionally comparable to the assessee as it is engaged in manufacturing air-conditioners, refrigeration products and systems, etc. The learned DRP, vide its directions, rejected the objections filed by the assessee and affirmed the findings of the TPO in considering this company as comparable to the assessee. Being aggrieved, the assessee has sought exclusion of this company for benchmarking the international transaction of “sale of finished goods”.

44. During the hearing, the learned AR submitted that is Daikin Airconditioning India Private Limited is engaged in the business of manufacturing and trading of air-conditioners. While the assessee is only manufacturing an intermediate product. Thus, it was submitted that an air conditioner manufacturer cannot be considered as comparable to the assessee. On the other hand, the learned DR vehemently relied upon the order passed by the lower authorities in respect of this company.

45. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Annual Report of is Daikin Airconditioning India Private Limited, forming part of the Paper Book Vol-5 from pages 212-216, we find that this company is a manufacturer of air conditioners. Thus, we find merit in the submissions of the assessee that this company cannot be considered as comparable to the assessee, which is only manufacturing an intermediate product and not the final product. Accordingly, we direct the AO/TPO to exclude is Daikin Airconditioning India Private Limited for benchmarking the international transaction of “sale of finished goods”.

46. The next company sought to be excluded by the assessee is Rockwell Industries Ltd. This company was considered as comparable by the TPO, vide order passed under section 92CA(3) of the Act, on the basis that it is functionally comparable to the assessee as it is engaged in manufacturing air-conditioners, refrigeration products and systems, etc. The learned DRP, vide its directions, rejected the objections filed by the assessee and affirmed the findings of the TPO in considering this company as comparable to the assessee. Being aggrieved, the assessee has sought exclusion of this company for benchmarking the international transaction of “sale of finished goods”.

47. During the hearing, the learned AR submitted that Rockwell Industries Ltd is engaged in the business of manufacturing commercial coolers and freezers. Thus, it was submitted that this company cannot be said to be functionally comparable to the assessee. On the other hand, the learned DR vehemently relied upon the order passed by the lower authorities in respect of this company.

48. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Annual Report of Rockwell Industries Ltd., forming part of the Paper Book Vol-5 from pages 217-221, we find that this company is engaged in the manufacturing of commercial refrigeration appliances such as freezers, eutectic freezers, water coolers, visi coolers, push-cart freezers, etc. and kitchen refrigeration appliances, which include stainless steel cabinets in both horizontal and vertical form. Therefore, having perused the details provided in the Annual Report, we are of the considered view that Rockwell Industries Ltd cannot be said to be comparable to the assessee. Accordingly, we direct the AO/TPO to exclude Rockwell Industries Ltd for benchmarking the international transaction of “sale of finished goods”.

49. The next company sought to be excluded by the assessee is Western Refrigeration Private Limited. This company was considered as comparable by the TPO, vide order passed under section 92CA(3) of the Act, on the basis that it is functionally comparable to the assessee as it is engaged in manufacturing air-conditioners, refrigeration products and systems, etc. The learned DRP, vide its directions, rejected the objections filed by the assessee and affirmed the findings of the TPO in considering this company as comparable to the assessee. Being aggrieved, the assessee has sought exclusion of this company for benchmarking the international transaction of “sale of finished goods”.

50. During the hearing, the learned AR submitted that Western Refrigeration Private Limited is a manufacturer and trader of refrigerators for commercial use. Thus, this company cannot be considered as comparable to the assessee. On the other hand, the learned DR vehemently relied upon the order passed by the lower authorities in respect of this company.

51. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Annual Report of Western Refrigeration Private Limited, forming part of the Paper Book Vol-6 from pages 222-230, we find that this company claims to be the manufacturer of refrigerators for commercial use. Further, the company claims to be manufacturing visi-cooler and deep-freezers at its factory in Gujarat and visi-cooler, dispensers and stainless-steel refrigerators at its factory in Shahpur. Thus, we find merit in the submissions of the assessee that this company cannot be considered as comparable to the assessee, which is only manufacturing an intermediate product and not the final product. Accordingly, we direct the AO/TPO to exclude Western Refrigeration Private Limited for benchmarking the international transaction of “sale of finished goods”.

52. The next company sought to be excluded by the assessee is Sidwal Refrigeration Industries Private Limited. This company was considered as comparable by the TPO, vide order passed under section 92CA(3) of the Act, on the basis that it is functionally comparable to the assessee as it is engaged in manufacturing air-conditioners, refrigeration products and systems, etc. The learned DRP, vide its directions, rejected the objections filed by the assessee and affirmed the findings of the TPO in considering this company as comparable to the assessee. Being aggrieved, the assessee has sought exclusion of this company for benchmarking the international transaction of “sale of finished goods”.

53. During the hearing, the learned AR submitted that Sidwal Refrigeration Industries Private Limited is engaged in the business of manufacturing heating, ventilation and air-conditioning products, which is not functionally comparable to the assessee. On the other hand, the learned DR vehemently relied upon the order passed by the lower authorities in respect of this company.

54. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Annual Report of Sidwal Refrigeration Industries Private Limited, forming part of the Paper Book Vol-6 on pages 231, we find that this company is engaged in the business of manufacturing Heating, Ventilation and Air-Conditioning Products and services for mobility applications. Thus, we find merit in the submissions of the assessee that this company cannot be considered as comparable to the assessee, which is only manufacturing an intermediate product and not the final product. Accordingly, we direct the AO/TPO to exclude Sidwal Refrigeration Industries Private Limited for benchmarking the international transaction of “sale of finished goods”.

55. To sum up, we direct Voltas Limited, Daikin Airconditioning India Private Limited, Rockwell Industries Limited, Western Refrigeration Private Limited and Sidwal Refrigeration Industries Private Limited to be excluded while benchmarking the international transaction of “sale of finished goods”. While the directions of the AO/TPO to consider Frick India Ltd as comparable for benchmarking the international transaction of “sale of finished goods” are upheld.

56. Accordingly, Ground No. 7 raised in assessee’s appeal is dismissed. While Grounds No.8 – 12, raised in assessee’s appeal, are allowed.

57. Grounds No. 13 and 14, raised in assessee’s appeal, pertain to the transfer pricing adjustment on account of outstanding trade receivables from the associated enterprises.

58. The brief facts of the case pertaining to this issue, as emanating from the record, are: During the transfer pricing adjustment proceedings, it was observed that certain invoices raised by the assessee to its associated enterprise were not paid within the due date of realisation as per the terms, and there was a delay in the receivables for goods sold by the assessee. The TPO, vide order passed under section 92CA(3) of the Act, held that the assessee has provided benefit to its associated enterprise by way of advancement of an interest-free loan in the garb of delayed receipt of receivables, which funds could have been otherwise deployed for at least earning interest income. The TPO held that the assessee has incurred costs in connection with benefits and services provided to the associated enterprise by way of delayed receipt of receivables. Accordingly, the TPO held that the delay in receipt of receivables from the associated enterprise is an international transaction under section 92B(1) read with clause (v) of section 92F of the Act. The TPO also rejected the plea of the assessee to benchmark the receivable transaction using a combined transaction approach. Thus, the TPO computed interest at 5.37% (i.e., @LIBOR + 450 BPS) for the delayed receipt of receivables from the associated enterprise. Accordingly, the TPO computed the arm’s length interest on outstanding receivables at Rs. 4,57,314/-. In conformity, the AO passed the draft assessment order under section 144C(1) of the Act. The learned DRP, vide its directions, upheld the findings of the TPO in levying the interest on outstanding receivables from the associated enterprise. In conformity, the AO, inter alia, passed the impugned final assessment order. Being aggrieved, the assessee is in appeal before us.

59. We have considered the submissions of both sides and perused the material available on record. We find that the term “international transaction” is defined in the Explanation to section 92B of the Act, and it specifically includes “deferred payment or receivable”. From the perusal of the order passed by the TPO, it is evident that the invoices raised by the assessee on its associated enterprises were delayed to an extent of 237 days. Therefore, we do not find any infirmity in the findings of the lower authorities in treating delayed trade receivables as an international transaction. In the present case, it is pertinent to note that out of all the international transactions undertaken by the assessee with its associated enterprises, as noted in the foregoing paragraphs, only in respect of the international transaction of “sale of finished goods”, the assessee raised the invoices on its associated enterprises. Therefore, we are of the considered view that the outstanding trade receivables from the associated enterprises pertain only to the international transaction of “sale of finished goods”. Thus, the international transaction of outstanding receivables is closely linked to the main international transaction of “sale of finished goods”, and both transactions need to be benchmarked using a combined-transaction approach.

60. In the present case, it is evident from the record that the TPO did not grant any working capital adjustment. At this stage, it is pertinent to note that as per Rule 10B(3)(ii) of the Income Tax Rules, 1962 (“the Rules”), an uncontrolled transaction shall be comparable to an international transaction if reasonably accurate adjustments can be made to eliminate the material effects of such differences. Further, TNMM benchmarking, as per Rule 10B(1)(e) of the Rules, also supports adjustments to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions.

61. As the impact of the receivables gets factored into the taxpayer’s working capital and thereby on its pricing/profitability vis-a-vis that of its comparables, we direct the AO/TPO to compute and grant a working capital adjustment in respect of the international transaction of “sale of finished goods”. Once a working capital adjustment is granted under TNMM benchmarking, the impact of delayed receivables is subsumed in the profitability analysis, and no separate adjustment for notional interest on delayed receivables is warranted. We order accordingly. As a result, Grounds No. 13 and 14 raised in assessee’s appeal are allowed for statistical purposes.

62. Ground No.15, raised in assessee’s appeal, pertains to set off of unabsorbed depreciation against income from other sources. At the outset, from the perusal of the provisions of section 32(2) of the Act, we find that brought forward unabsorbed depreciation from the earlier years can only be set off against the profits or gains from the business. Therefore, we do not find any merit in the plea of the assessee for seeking set-off of unabsorbed depreciation against income from other sources. As a result, Ground No. 15 raised in assessee’s appeal is dismissed

63. Ground No.16 is general in nature and, in view of our aforesaid findings, requires no specific adjudication.

64. In the result, the appeal filed by the assessee is partly allowed.