Non-Utilized Man hours must be Excluded while allocating Cost to AE Transactions: ITAT [Read Order]

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The Delhi Bench of Income Tax Appellate Tribunal ( ITAT ) in Triune Energy Services vs. DCIT held that non-utilized man hours must be excluded while allocating cost to Associated Enterprises (A.E).

The assessee engaged in the business of engineering and design services in sector of oil and gas services including offshore construction and drilling to its Associated Enterprises (AEs) as well as to Non-Associated Enterprises (Non-AEs). An income return of Rs.4.71 Crores were filed. As there was international transaction carried out by the assessee with its Associated Enterprises (AEs) the Assessing officer (A.O) referred the matter to the Transfer Pricing Officer (TPO). The final assessment order computed the assessee’s income as Rs.14.15 Crores. The assessee selected Comparable Uncontrolled Price (CUP) method as the most appropriate method. According to the Ld. TPO, the assessee had not provided details of services provided to AEs and non-AEs as required for a strict comparability under the CUP method and the geographical area of the AE and Non-AE was also different.

TPO rejected the CUP method and chose Transactional Net Margin Method (TNMM) as most appropriate method using the operating Profit/Total Cost (OP/TC) and Profit Level Indicator (PLI) for benchmarking the international transaction of the assessee. The TPO allocated the operating cost in respect of the AE transaction in the ratio of total man-hours consumed (81962) towards AE transactions to the total man-hours (359692) consumed both for the AE and non-AE. The assessee objected to the above allocation of cost towards AEs transaction. According to the assessee, out of the total manhours of 81,962 billed to AE, only 5695 hours were utilized and balance 76267 hours were non-utilized. Before the Dispute Resolution Panel (DRP) the assessee raised objection regarding the use of TNMM as most appropriate method. This objection was rejected. Aggrieved the assessee appealed before the Tribunal.

The Counsel for the assessee argued that according to the terms of agreement between the assessee and its AEs, in case if the actual utilization of the hours of the assessee falls below the committed hours, the AEs shall pay to the assessee for the unutilized hours at an agreed rate. He further submitted that if utilized man-hour is taken as basis of allocation of cost for AE transactions, then the said cost would work out to Rs.99 lacs and arm’s length price applying the average margin of comparables of 27.70 %, would work out to Rs.1.26 Crores which being less than the price charged by the assessee of Rs.3.10 Crores for man-hours utilized, no adjustment would be required to the value of the transaction reported by the assessee.

The Departmental Representative submitted that cost towards AE should be allocated on the basis of the committed man-hours rather than the man-hours utilized on the basis of the matching principles of revenue and expenses.

The bench comprising of Judicial Member Amit Shukla & Accountant Member O.P. Kant observed “In our opinion, the contention of the Ld. counsel is logical and on scientific basis. For allocation of cost between the AE and the non-AE transactions, different basis cannot be taken. In other words, we cannot take different yardsticks for measuring cost incurred toward AE and non-AE transaction by same set of manpower. Taking committed man-hours in the case of AE, which also included unutilized man-hours, would distort the allocation key. Thus, the basis of allocation of the cost towards the AE transaction should be on man-hours utilized only and not on man-hours which have been committed by the AE for payment.”

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