Segmental Accounts in Transfer Pricing: Key Insights and Judicial Perspectives
CA Gaurav Garg
Chairman, NIRC of ICAI [2023-24] I Transfer Pricing I NR Taxation I Income Tax I Chartered Accountant I Speaker
Segmental accounts are important in transfer pricing, especially for enterprises with diverse functional profiles such as manufacturing, trading, or service operations. Segmental accounts helps in a understanding revenue, cost and profitability among different business segments, allowing for a more appropriate determination of the arm's length price (ALP). However, disputes often arise over their preparation, reliability, and acceptability. This article explores the legal and practical dimensions of segmental accounts, drawing on key case laws to highlight various perspectives.
Key Aspects of Segmental Accounts
Purpose and Importance of Segmental Accounts
Preparation and Allocation Methodology
Acceptance and Judicial Oversight
Recent Tribunal Rulings with Regard to Segmental Accounts
21. We have given thoughtful consideration to the orders of the authorities below. At the very outset, we would like to refer to the decision of the Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communications India Pvt Ltd 374 ITR 118 wherein the Hon'ble High Court held that in cases where the assessee is engaged in the manufacturing/sales trading activities it would be inappropriate to apply TNMM on entity wide basis.
23. In our considered opinion and in light of the provisions of section 92 to 94 of the Act, international transactions are to be taken into consideration. Therefore, in our considered opinion, segmental results are to be considered and not the profit at entity level.
24. Moreover, considering the factual matrix of the case in hand, nature of transactions are functionally different and even the risks assumed are different. We are, therefore, inclined to accept the stand of the ld. counsel for the assessee to bench mark the manufacturing segment and the trading segment separately.
2. DIC India Limited (Kolkata ITAT, ITA No. 2558/KOL/2017 for A.Y. 2013-14)
“18. ...In the given facts of the present case, we note that the appellant has two separate & distinct activities viz., manufacturing of printing inks, blankets and trading in press chemicals. It is well understood that the functions involved in manufacturing activities, risks assumed, assets employed are significantly different and higher than the trading activity..... generally seen that the profitability of a manufacturing enterprise is higher than the profitability of a trading enterprise. As already held earlier, the cross subsidization of the international transactions in a combined approach is impermissible since it results in distorted presentation of facts. Hence if both the manufacturing & trading segments of the appellant are aggregated, the combined profit margin would throw up an inappropriate result in as much as it cannot be compared either with companies engaged in manufacture of printing ink or companies engaged in trading activities. Furthermore in order to benchmark each set of transactions distinctly, it is imperative to use the segmented information of the manufacturing activity and trading activity of the appellant. On these facts we are therefore of the view that the segmented results of the appellant are required to be used for benchmarking the international transactions.
19. We further hold that the argument of the Ld. DR that, since the segmented information did not form part of the published financial statements; it ought not be used, to be devoid of any merit. At the outset, we find merit in the submissions of the ld. AR that whether a particular segment is reportable or non-reportable under AS-17 prescribed by ICAI cannot be held to be decisive criteria to uphold the reliability of the segment identified for the purposes of income-tax laws...."
3. Schneider Electric IT Business India Pvt. Ltd. (Bangalore ITAT, IT(TP)A No.679/Bang/2022, AY 2018-19)
14. From the above findings of the DRP, it is clear that the reason for rejection is that the assessee has not provided any justification for allocation of expenses between the contract manufacturing segment and distributing segment. We also notice that the coordinate Bench of the Tribunal in assessee’s own case for AY 2017-18 IT(TP)A No.185/Bang/2022 dated 1.9.2022 has remitted the issue back to the DRP for the reason that there was no specific finding. In the light of this discussion, we deem it fit to remit the issue back to the TPO for consideration of the issue afresh after giving reasonable opportunity of being heard to the assessee.
4. Spectris Technologies Pvt. Ltd.(Delhi ITAT, ITA No. 1818/DEL/2013, A.Y. 2007-08)
16. .... the assessee has allocated common expenses and has also given basis of apportionment. We find that the ld. CIT(A) has put a doubt on whether segmental accounts are to be accepted and the only reason given by the authorities, as we understand from the respective orders, is that it is not audited.
17. Merely because segmental accounts are not audited cannot make them untrustworthy without pointing out any specific defect/error/fallacy in them.....
18. As mentioned elsewhere, the assessee has not only provided segmental account but has also allocated expenses and has given basis of allocation. Considering the facts of the case in totality, we do not find any merit in the stand taken by the TPO/Assessing Officer as confirmed by the ld. CIT(A). We, accordingly, direct the Assessing Officer to delete the impugned adjustment.
Conclusion
Segmental accounts serve as an important tool for appropriate transfer pricing evaluations, ensuring that distinct operations are assessed on their merits. The juris prudence is also in the favour of segmental accounts. Taxpayers must invest in developing robust documentation supporting segmental analysis methodologies.