2017 (1) TMI 1776 - HC - Income Tax

High Court Upholds Tribunal Decision on Abnormal Expenses Claim for Assessment Year 2008-09

M/s. Royal Star Jewellery Pvt. Ltd. Versus The Asstt. Commissioner of Income-tax & Ors.

The High Court upheld the Tribunal's decision to reject the appellant's claim of abnormal expenses amounting to Rs. 2,06,11,944 for assessment year ... Rejecting claim of the appellant of abnormal expenses - Tribunal found that the claim of the assessee is of adjustment on account of the low capacity utilization - Whether Income-tax Appellate Tribunal was right in upholding the order of the Respondent A.O. in rejecting claim of the appellant of abnormal expenses? - HELD THAT:- The business of the assessee was segregated into two parts, namely, manufacture and distribution. There were various international transactions with the aforesaid associate enterprises, but there was a transfer pricing report which adopted the transaction net margin method considering it to be the most appropriate method for the purpose of benchmarking its activities under the manufacturing and distribution segments separately. The details of all these activities are set out and then what has been argued is that the item No.3 of the table is of Professional Consultancy. That was a case where a team of experienced professionals visited the assessee's vendors and performed various activities in respect of standardization and improvement of the process at the vendor's site. Thus, they carried out the work to improve the quality. The assessee furnished the details of the work performed by professionals and the details, according to the assessee, was enough for the purposes of making the adjustments. This is a case where there was no absence of materials, but whether the materials supplied were sufficient and adequate for the purpose of making the adjustments or otherwise. To our mind, this case is completely distinct from the case at hand. Here, the assessee projects that the activities performed and carried out by it by themselves must be taken as a benchmark or as a standardized practice. There is no need to make any comparison or draw any comparables. The Tribunal found that unless the standardization in the jewellery manufacturing units is established and by bringing in the necessary materials, the assessee's consumption by itself and without anything more cannot be accepted. Therefore, we do not think that the Punjab & Haryana decision would be of any assistance. Similarly in the case of the Tribunal's order, what we have found is that the assessee was a joint venture and with a Switzerland based unit. It was engaged in the business of manufacturing of diamonds and precious stones studded jewellery. The return of income was filed and declaring a loss. The transfer pricing study report was submitted and the AO noticed that the assessee has entered into various international transactions with its associate enterprises, including export of studded jewellery. He, therefore, made the reference and the Transfer Pricing Officer determined the arm's length price. As far as the capacity utilization is concerned, there is an explanation offered by the assessee that it was operating at 50% of its actual capacity during the year under consideration and, therefore, its operating profit margin was lower as compared to all comparables selected. Thus, there were comparables and on record. It is in relation to the comparables performance that the Transfer Pricing Officer was, by taking that as a benchmark, applying the same to the assessee before the Tribunal. The assessee was a relatively new unit having put in only two years after its existence and, therefore, could not achieve the optimum capacity. That is why it urged that it was operating at 50% of its actual capacity. Thus, materials were already on record and there was no dispute about it. It is in these circumstances that the Tribunal found fault with the approach of the authorities in taking the comparables as the benchmark and applying them to a relatively new unit. Therefore, to our mind, even this Tribunal's order cannot assist the assessee in the facts and circumstances of our case. Issues:Appeal against Tribunal's order for assessment year 2008-09; Rejection of claim of abnormal expenses of Rs. 2,06,11,944.Analysis:The primary issue in this case revolves around the rejection of the appellant's claim of abnormal expenses amounting to Rs. 2,06,11,944. The appellant contended that the Tribunal erred in rejecting this claim both factually and legally. The Tribunal had asked for capacity utilization figures of comparables, which the appellant argued was not necessary and beyond their obligation. The appellant, engaged in jewellery manufacturing, emphasized the importance of considering low capacity utilization, citing a judgment of the Punjab & Haryana High Court. However, the Tribunal found the lack of material on capacity utilization comparables as a hindrance to making adjustments, especially in the context of jewellery manufacturing involving diverse products with varying production requirements.The Assessing Officer's observations were crucial in this case. The appellant, involved in manufacturing and trading diamonds and jewellery, objected to the Transfer Pricing Officer's adjustments and the selection of comparables. The Dispute Resolution Panel rejected the claim of abnormal expenses due to low capacity utilization, which was then challenged before the Tribunal. The Tribunal scrutinized the claim for adjustment based on low capacity utilization, which the appellant argued would significantly impact their margin. However, the Tribunal found the absence of capacity utilization figures of comparables as a barrier to making such adjustments, emphasizing the need for standardized capacity in the complex jewellery manufacturing sector.Comparisons were drawn with a judgment of the Punjab & Haryana High Court involving a wholly-owned subsidiary engaged in manufacturing activities. In that case, the adequacy of materials supplied for making adjustments was questioned, unlike the present scenario where the Tribunal found the appellant's self-proclaimed benchmarking insufficient without comparative data on capacity utilization. Another case involving a joint venture in diamond and jewellery manufacturing highlighted the importance of comparables' performance in determining arm's length price. The Tribunal's order in this case also emphasized the inappropriateness of applying comparables' benchmarks to a relatively new unit operating below optimal capacity.In conclusion, the High Court dismissed the appeal, finding no perversity or legal errors in the Tribunal's approach. The factual findings did not raise substantial questions of law, leading to the rejection of the appellant's claim of abnormal expenses due to low capacity utilization. The judgment underscores the significance of comparative data and standardized benchmarks in assessing claims related to capacity utilization and abnormal expenses in the context of transfer pricing disputes.