ALP recomputed by TPO is Invalid as Assesee Followed Prescribed method (TNMM) u/s 92C of Income Tax Act : ITAT allows appeal of Schaeffler India Ltd [Read Order]

In a recent case, the Ahmedabad bench of the Income Tax Appellate Tribunal (ITAT) allowed the appeal of Schaeffler India Ltd. on finding that ALP recomputed by TPO is Invalid as the assessee followed the prescribed method (TNMM) under section 92C of the Income Tax Act, 1961. It was observed that neither the TPO nor CIT(A) ever held that the ALP was computed outside the statutory provisions, or that the study report lacked diligence or was not prepared in good faith.

The Assessee, challenged the order passed by the Commissioner of Income Tax (Appeal), ( CIT(A), National Faceless Appeal Centre ( “NFAC”), Delhi vide order dated 30.08.2024 passed for A.Y. 2009-10. The assessee filed its return of income at a loss of Rs. (-)19,80,74,542/-. The case was selected for scrutiny, and assessment under section 143(3) read with section 144C(3) of the Income Tax Act, 1961 (Act), was finalized on 29.05.2013, determining the assessed loss at Rs. (-)2,00,59,396/-. The assessee is engaged in manufacturing and trading in needle roller bearings and engine components.

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During the course of assessment proceedings, two main disallowances were made in the assessment order: a Transfer Pricing adjustment amounting to Rs. 17,15,40,000/- and a disallowance of additional depreciation on second-hand machinery valued at Rs. 64,75,146/-. As a result, penalty proceedings under section 271(1)(c) were initiated on the assessee.

In appeal before CIT(A), since the assessee did not contest the disallowance of additional depreciation on second-hand machinery, penalty of Rs. 22,00,950/- under section 271(1)(c) was levied vide order dated 25.03.2015. In relation to the Transfer Pricing adjustment, the assessee had entered into international transactions with associated enterprises amounting to Rs. 1,61,33,11,882/-.

In the Transfer Pricing proceedings, the Transfer Pricing Officer (TPO), made an upward adjustment of Rs. 17,15,40,000/-. This included Rs. 12,45,49,000/- relating to manufacturing business and Rs. 4,69,91,000/- to the distribution segment. Based on the TPO’s order, the same amount was added to the assessee's returned income, and penalty proceedings under section 271(1)(c) were again initiated for furnishing inaccurate particulars. The assessee challenged the CIT(A)’s decision before the ITAT, which remanded the case back to the CIT(A) with directions to provide the assessee a proper opportunity of hearing.

Following this, the CIT(A) passed an order dated 15.11.2016 directing the Assessing Officer to recompute the arm’s length price (ALP). Based on this, the DCIT, Pune, vide order dated 16.01.2017, revised the TP adjustment to Rs. 8,13,00,000/- for the manufacturing segment and deleted the Rs. 4,69,91,000/- adjustment for the trading segment. The assessee contended that the penalty of Rs. 22,00,950/- had already been deleted by the ITAT; however, this argument was not accepted by the Tax Authorities.

The Assessing Officer held that the penalty imposed on the disallowance of depreciation was levied through a separate order dated 25.03.2015, and the assessee had not offered any explanation regarding the TP adjustment of Rs. 8,13,00,000/- . Therefore, the Assessing Officer held that this was a fit case for imposition of penalty under section 271(1)(c) for furnishing inaccurate particulars of income.

In appeal before the Commissioner (Appeals), the assessee contended that it had determined the Arm’s Length Price of its international transactions with Associated Enterprises using the Transactional Net MarginMethod (TNMM), which was the most appropriate method under section 92C of the Act.

For the purpose of benchmarking, the Assessee selected comparables by applying specific search filters, which were clearly specified in its transfer pricing study report. The Profit Level Indicator (PLI) was calculated using the Profit Before Depreciation, Interest, and Tax to Sales (PBDIT/Sales) ratio, primarily due to higher depreciation rates charged by the Assessee and underutilization of fixed assets compared to comparables. This computation yielded an average PLI of 5.38% for comparable companies, whereas the Assessee’s own PLI stood at 12.60%, indicating that the international transactions under the manufacturing segment were at arm’s length.

The assessee submitted all relevant documents and justifications for its method and comparables during assessment. However, the Transfer Pricing Officer (TPO) disagreed with the assessee’s approach, thereby changing the comparable set by relying on data from the preceding year and rejecting certain filters, particularly the ones relating to manufacturing revenue percentage and turnover multiples.

The TPO also rejected the use of PBDIT as the PLI and instead used Profit Before Interest and Tax (PBIT) to Sales, thus computing a lower PLI of -6.58% for the assessee and 4.11% for the comparable set, which led to an upward adjustment of Rs. 12.46 crore. The Assessee submitted before CIT(Appeals) that such rejection of its methodology and adjustments was not based on any identified defects in the documentation or reasoning but reflected merely a difference in opinion. It was further pointed out that the assessee had made certain adjustments—such as excluding foreign exchange loss, bad debts, and provisions for obsolete inventory-on the grounds that these were already disallowed in the return of income and had been accepted in prior years.

However, the TPO disallowed these adjustments in the relevant assessment year without justifying the inconsistency with past practice. The assessee argued that under Explanation 7 to section 271(1)(c), penalty for transfer pricing adjustments can be levied only if it is proven that the price charged was not determined in accordance with section 92C of the Act and not done in good faith and with due diligence. In this case, the AO failed to make any reference to Explanation 7 in the penalty order or record any findings suggesting non-compliance with these conditions. There was no claim by the AO or the TPO that the assessee’s selection of TNMM was inappropriate or that its method of determining ALP was not in accordance with section 92C of the Act.

On the contrary, both the TPO and the ITAT, in the quantum proceedings, had accepted TNMM as the most appropriate method. Further, the Assessee contended before CIT(Appeals) that the search filters applied in selecting comparables by the assessee were consistent with judicial precedents and were applied in good faith. The filter for 90% minimum manufacturing revenue was based on the fact that 100% of the Assessee’s revenue in the relevant segment came from manufacturing.

Although the Department chose to apply a 75% threshold, this was merely a difference in opinion rather than a finding of fault or inaccuracy in the assessee’s approach. In support of its decision to use PBDIT/Sales as the PLI, the assessee supported this position on various grounds such as the charging of depreciation at higher-than-standard rates, substantial recent expansion, and underutilization of capacity—all of which distorted the depreciation figures relative to comparable companies.

The assessee is in appeal before us against the aforesaid order passed by CIT(Appeals) confirming the levy of penalty under section 271(1)(c) of the Act. Before us, the Counsel for the assessee primarily reiterated the arguments taken before CIT(Appeals).

The two member bench of Dr. Brr Kumar, Vice President & Shri Siddhartha Nautiyal, Judicial Member observed that the assessee had used a prescribed method (TNMM) under section 92C of the Act and disclosed the selection of filters, comparables, and operating margin computation in the transfer pricing study report.

Neither the TPO nor CIT(A) ever held that the ALP was computed outside the statutory provisions, or that the study report lacked diligence or was not prepared in good faith. The tribunal viewed that the necessary conditions under Explanation 7 for imposing penalty are not satisfied and held that the penalty levied by the AO is unsustainable in law and is hereby deleted. The appeal of the assessee is allowed.

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