TaxTMI 
TaxTMI 
2015 (8) TMI 755
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.... namely, M/s Eicher Motors and M/s Force Motors. 3. Briefly stated, the facts of the case are that the assessee was established as an Indian company in 1990 as a wholly owned subsidiary of a Claas KGaA mbH, Germany. Until 31.8.2002, the assessee was known as Escorts Claas Ltd., with 60:40 joint venture between Escorts India Ltd., and Claas, Germany. Thereafter, the entire shareholding was acquired by Claas, Germany. The assessee's main activity is manufacture and sale of harvester combines in India and export of harvester combines and engine harvester combines and engine related products, licensed by Claas Group. The assessee manufactures two types of harvester combines, namely, wheel based and track based. Certain international transactions were reported by the assessee including purchase of raw materials; sale of harvesters and spares; purchase of computer; payment for administrative and software support services; and receipt of market support services. To demonstrate that its international transactions were at arm's length price (ALP), the assessee applied the Transactional Net Margin Method (TNMM) as the most appropriate method with the Profit Level Indicator (PLI) of Operat....
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....sed that Eicher Motors is engaged in the business of manufacture and sale of tractors and not harvester combines. The question arises as to whether Eicher Motors, manufacturing tractors can be considered as a good comparable of the assessee, manufacturing harvester combines. The first and the foremost parameter for testing the comparability of a company is its functional similarity. Other factors follow later on. Functional similarity is sine qua non for any comparability analysis. The degree of functional similarity may vary depending upon the method of determining arm's length price (ALP). Whereas the Comparable uncontrolled method (CUP) demands the scale of similarity of a highest order, the same can be compromised to some extent under the TNMM. Compromising similarity to some extent under the TNMM does not mean switching over to an altogether different product. A comparison even under the TNMM is contemplated with 'a comparable uncontrolled transaction.' Unless a company is functionally similar, there can be no question of treating it as a probable comparable in the first instance for further evaluation. 4.3. Adverting to the facts of the instant case, we find that the ld. C....
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....ed at the average capacity utilization of 44%. That is how, the assessee claimed capacity utilization adjustment by reducing its operating costs accordingly. In support of deduction, the assessee filed a report of Mr. Chandra Wadhva, a Cost Accountant. As per this report, the capacity utilization of the assessee as well as the comparables was initially raised to 100%. The TPO partly accepted the claim of the assessee. He considered VST Tractors and Tillers and Punjab Tractors Ltd. (Seg.) for the purposes of allowing capacity adjustment with an average capacity utilization taken at 54%. Thereafter, he restricted the reduction in operating costs of the assessee due to capacity utilization, to some Administrative costs and other expenses. As against the assessee's actual deduction of Rs. 6,65,79,916 for such selective items of administrative and other expenses, the TPO adjusted such costs to Rs. 6,30,30,739 by applying the factor of 29/54 (29%, being, the assessee's capacity utilization and 54%, being, the average capacity utilization of comparables chosen by him). Similarly, he reduced the amount of Depreciation claimed by the assessee at Rs. 1,19,60,921 to Rs. 64,23,458 by applying ....
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.... the costs qualifying for adjustment. However, the adjustment has been ultimately allowed from the operating costs incurred by the assessee. In such circumstances, the question arises as to whether the action of the authorities in allowing the reduction of the operating costs incurred by the assessee, is in accordance with law? In order to find answer to this question, we need to refer to the manner of computation of the arm's length price under TNMM, which has been set out in Rule 10B(1)(e) as under:- "(e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base ; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into acc....
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....stment in such a manner so as to bring both the international transaction and comparable cases at the same pedestal. In other words, if there are no differences in these two, then the average of the net operating profit margin of the comparable companies becomes a benchmark. However, in case there are some differences between the comparables and the assessee, then the effect of such differences should be ironed out by making suitable adjustment to the operating profit margin of comparables. That is the way for bringing both the transactions, namely, the international transaction and the comparable uncontrolled transactions, on the same platform for making a meaningful and effective comparison. The above analysis overtly transpires that the law provides for adjusting the profit margin of comparables on account of the material differences between the international transaction of the assessee and comparable uncontrolled transactions. It is not the other way around to adjust the profit margin of the assessee. In other words, the net operating profit margin realized by the assessee from its international transaction is to be computed as such, without adjusting it on account of differenc....
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....tilization of capacity. Accordingly, such variable operating costs remain unchanged. The adjustment is called for only in respect of the fixed operating costs and fixed part of semi-variable costs. Such costs are scaled up or down by considering the percentage of capacity utilization by the assessee and such comparable. It can be illustrated with the help of a simple example. Suppose the fixed costs incurred by a comparable (say, A) are Rs. 100 and it has capacity utilization of 50% as against the capacity utilization of 25% by the assessee. The above percentages show that the assessee has incurred full fixed costs with 25% of the utilization of its capacity, as against A incurring full fixed costs with 50% of its capacity utilization. This divulges that the assessee has incurred relatively more fixed costs and A has incurred lower costs. In order to make an effective comparison, there arises a need to obliterate the effect of this difference in capacity utilizations. It can be done by proportionately scaling up the fixed costs incurred by A so as to make it fully comparable with the assessee. This we can do by increasing the fixed costs of A to Rs. 200 (Rs.100 into 50/25) as again....
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....djustment afresh in terms of our above observations. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings. 11.1. Ground no. 2 is against the deletion of addition of Rs. 61,762/- on account of capitalization of Software expenses. Succinctly, the facts of this ground are that the assessee claimed deduction amounting to Rs. 27,97,008/- towards software expenses. On perusal of details of such expenses, it was observed by the AO that a sum of Rs. 1,49,611/- was spent as subscription for anti-virus software, Rs. 2,895/- for website charges and Rs. 1,900/- towards purchase of modem. The AO capitalized these three items with a total of Rs. 1,54,406/- and allowed depreciation as applicable to computers on such amount @ 60%. This led to the making of addition of Rs. 61,762/-. The ld. CIT(A) deleted the addition. 11.2. After considering the rival submissions and perusing the relevant material on record, we find that the first item is anti-virus software subscription for which a sum of Rs. 1,49,611/- was paid by the assessee. On being called upon to produce the bill for this software subscription, the ld. AR expressed his inability a....