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.

Many a times, the auditors of the company may qualify the audit report and comment that profits as disclosed in the financial statements do not reflect true and correct profit.  The auditors may state that either the profit is understated or overstated.  The issue that arises for consideration is, what is the impact of auditor qualification on computation of operating margin of the assessee and the comparable companies.  This issue is dealt by the Courts in the following decisions:

M/s Premier Exploration Services Pvt Ltd v ITO TS-318-ITAT-2013(Del)-TP – While computing margins of the comparable, the TPO had ignored the qualification given by auditor in the published accounts of the comparable stating that profit is overstated by Rs 2.72 crore. The Assessee contended that profit of the comparable should be reduced by Rs 2.72 crore as per remarks of the auditor.

The ITAT observed that the auditor have qualified the accounts stating that the profits are overstated by Rs 2.72 crore. The ITAT held that that there was an abnormality in the accounts of comparable by overstating the profit to the tune of Rs 2.72 crore and which needs to be adjusted while working out the OP/TC of the comparable companies.

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