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.
At the year end, provisions for expenses are made on estimation basis. Generally when provisions are made, they are considered as part of operating cost. These provisions may be reversed in the succeeding year when the detail of actual expenses are available. Ideally, if when a provision is made, same is considered as part of operating cost, the reversal also should be considered as part of operating income. The issue that arises for consideration is whether provisions written back or reversal of provision can be considered as operating in nature while computing operating margins.
This issue has been dealt in the following cases:
Case Laws holding write back of Provision is Operating in Nature
M/s Sony India Pvt Ltd v DCIT [2008] 114 ITD 448 (Del) : [2008] 118 TTJ (Del) 865 – The taxpayer had international transactions with its AEs. Both taxpayer and TPO justified by adopting TNMM. However, while computing operating margins, the TPO excluded provision written back credited to the P&L account from the operating income. The TPO observed that it is merely accounting entry and has nothing to do with the operations of the taxpayer. Similarly, the TPO excluded balances written back from the operating income.
The ITAT observed that creation of unpaid liability and its write back is a normal incident of a business operation. It is a settled and well-accepted proposition that for computing ALP adjustment can be made only on account of differences. It was not possible to believe that other comparable entities taken into consideration are not making and writing back provision of liabilities no more required. The ITAT observed that there was no material nor was there any finding to support action of the tax department. The expenses for which provisions were originally made were considered operating in nature and allowed in assessment. These provisions no longer required by the taxpayer during the year under review were reversed in the books of account as per mercantile system of accounting and shown as income. Therefore, on facts the ITAT held that there is no justification for excluding provisions written back in the profit and loss account as not forming part of the operating profit of the taxpayer. The ITAT took a similar view for balances written back.
Suessen Asia (P.) Ltd.v. ACIT [2018] 90 taxmann.com 52 (Pune – Trib.) – The Assessee credited to P&L amount written back of deferred credit and import payments pursuant to waiver received from respective companies. The TPO held that aforesaid amount of write back was only an accounting entry and had no relation with the operation of the company for the year under consideration. The TPO treated the same as non-operating income. The ITAT held that provision written off on account of amounts written back in respect of expenses/liabilities (Deferred credit and import payments pursuant to waiver received from respective companies) is to be considered as part of operating income following the decision of Sony.
Haworth (India) (P.) Ltd. v. DCIT [2017] 88 taxmann.com 316 (Pune – Trib.) – The TPO held that liabilities written back and bad debts recovered are non-operating and excluded while computing operating margin of the assessee under MSS segment. Following Tribunal decision in case of Sony (supra), the ITAT held that the liabilities written back and bad debts recovered are operating in nature.
AMD India (P.) Ltd. v. ITO [2020] 114 taxmann.com 703 (Bangalore – Trib.) – The Assessee is exporter of service and therefore eligible to claim refund of service tax input. Accordingly, the Assessee had passed receivable entry for certain categories of services tax input. However, for certain categories of services tax input, the tax department denied refund of service tax. Accordingly, the assessee made provision against service tax refund receivable and simultaneously filed appeal before appellate authorities for claim of refund. During the year under consideration, certain appellate orders were received granting refund for certain categories of service tax input. Based on such orders, the assessee reversed the provision by crediting profit and loss account. The TPO considered the same as non-operating in nature. The ITAT held that reversal of provision for service tax written back in profit and loss account should be regarded as part of revenue of assessee while determining profit level indicator.
Other Decision taking similar view are as follows:
- BT (India) (P.) Ltd. v. ACIT 2018] 98 taxmann.com 416 (Delhi – Trib.) – held that provision written back should be considered as operating in nature.
- Logica Private Limited v ACIT IT (TP)A No. 1129/Bang/2011 : TS-131-ITAT-2013-BANG-TP.