Rule 10B of Income Tax Rules provides methodology for computation of ALP. Under TNMM, ‘net profit’ is used as benchmark for ALP computation. Rule 10B(1)(e)(i) provides for considering “net profit margin realised by the enterprise from an international transaction or SDT entered into with an associated enterprise”. Rule 10B(1)(e)(ii) provides for computation of ‘net profit margin in uncontrolled comparable transactions’. Therefore, while computing net margin realized by the enterprises (tested party as well as comparables) all incomes and expenses that are representative or comprised of business obligation should be considered.
The issue that come up before the Court was whether compensation paid by the taxpayer towards termination of property purchase agreement can be considered as abnormal and therefore non-operating in nature.
M/s SAP Labs India Pvt Ltd v ACIT (2012) 134 ITD 0253;  8 taxmann.com 207 (Bang) – The Taxpayer is a software development center established by the German Parent. It renders software development and related services to its AE. The taxpayer adopted TNMM as the MAM and determined ALP.
The TPO adopted TNMM. The TPO selected fresh set of comparables and recomputed the ALP. Accordingly, he made TP adjustment. The taxpayer contended that compensation paid towards termination of property purchase agreement should be considered as non-operating in nature.
The taxpayer had proposed to purchase a property and an agreement was entered into. As the taxpayer could acquire a better property on more favourable terms, the earlier proposal was dropped and agreement was terminated. This development resulted in payment of compensation. The ITAT observed that AO himself has disallowed this item as an item of capital expenditure. The ITAT held that it is not a regular operating expenditure of the taxpayer and is a classic example of extraordinary item. The ITAT therefore held that it should be excluded from the computation of operating margin of the taxpayer.