AI Drafter 
TaxTMI 
TaxTMI 
2016 (3) TMI 1121
X X X X Extracts X X X X
X X X X Extracts X X X X
.... assessee company. The assessee company is providing two types of services to its Associated Enterprise (AE) i.e. Digitising Services and Data Conversion/Creation Services. Both the services fall under the ambit of IT enabled services. During the course of assessment proceedings, the Assessing Officer observed that the assessee has carried out international transactions of more than Rs. 5 Crores. Therefore, he referred the matter to the Transfer Pricing Officer (TPO) u/s. 92CA of the Income Tax Act, 1961 (hereinafter referred to as "the Act"). The assessee during the period relevant to the assessment year under consideration had shown total sales of Rs. 11,07,77,000/- out of which international transactions with its AE were to the tune of Rs. 11,07,46,207/-. Apart from the above said international transactions, there were transactions amounting to Rs. 1,31,701/- relating to import of consumables and spare items. All the transactions were relating to the activity of providing IT enabled services. For benchmarking the transactions and determining Arm's Length Price (ALP) the assessee adopted Transactional Net Margin Method (TNMM) as the most appropriate method. For applying TNMM the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sioner of Income Tax (Appeals). 3. The assessee has raised following grounds in appeal: "1. General: 1.1. The honorable CIT (A) erred in law and on the facts and in circumstances of the case in confirming to the transfer pricing adjustment to the value of international transactions pertaining to Information Technology (IT) Enabled services made by the learned TPO of Rs. 1,57,97,452 entered into by the Appellant by rejecting the analysis undertaken by the Appellant in the Transfer Pricing Report to determine the arm's length price for its international transactions pertaining to export of services. 2. Rejection of functional adjustment made to PLI of the Appellant 2.1 The honorable CIT (A) erred in law and on the facts and in circumstances of the case in rejecting the functional adjustment made by the Appellant to its Profit Level Indicator. 3. Rejection of two comparable companies from the Transfer Pricing analysis 3.1 The honorable CIT (A) erred on the facts and in circumstances of the case in confirming the rej ection of the independent comparable companies "F I Sofex Ltd." and Fortune Informatics Ltd. (now known as "In....
X X X X Extracts X X X X
X X X X Extracts X X X X
....the first appellate proceedings. The ld. AR further submitted that the assessee is not working on cost plus base, the assessee is working on unit cost. The ld. AR referred to the contract between the CVJV Inc. USA and the assessee for the export of Embroidery Software design development effective from 01st April, 2003 at pages 226 to 228 of the paper book. The ld. AR also furnished revised PLI computation after adjusting the salary and employee cost of the assessee and the comparable companies. The ld. AR placed reliance on the following decisions of the Tribunal in support of his contentions that capacity utilization adjustment should be granted : i. Amdocs Business Services (P.) Ltd. Vs. DCIT, 54 SOT 46; ii. Genisys Integrating Systems (India) Pvt. Ltd. Vs. DCIT in ITA No. 1231/Bang/2010 decided on 05-08-2011; iii. Tasty Bite Eatables Limited Vs. ACIT in ITA No. 1682/PN/2011 decided on 10-06-2015. iv. DCIT Vs. Claas India Pvt. Ltd. in ITA No. 1783/Del/2011 decided on 12-08-2015. 4.1 The ld. AR further submitted that the authorities below have erred in excluding F I Sofex Limited and Fortune Informatics Limited from the list of comparables on....
X X X X Extracts X X X X
X X X X Extracts X X X X
....er utilization of the capacity is arrived at with respect to comparable companies. The assessee vide letter dated 01-12-2009 admitted that the details are not available. Thus, it is evident that the claim of the assessee is not based on any acceptable norms and is merely a superficial calculations. In respect of rejection of two comparable companies the ld. DR contended that both the companies during the period relevant to the assessment year under consideration had substantial loss and were having negative operating margin. Therefore, they were rightly rejected by the TPO and the Commissioner of Income Tax (Appeals). The ld. DR submitted that as far as ground no. 4 raised in the appeal with regard to benefit of safe harbour +/- 5% is concerned the provisions of section 92C(2) have been amended by the Finance Act, 2012 with retrospective effect from 01-04-2002. Therefore, the assessee cannot claim the benefit of +/- 5%, if the difference between the ALP determined by the TPO and actual price charged is beyond the +/- 5% margin. 6. The ld. AR of the assessee controverting the submissions made on behalf of the Department submitted that under utilization capacity adjustment is to b....
X X X X Extracts X X X X
X X X X Extracts X X X X
....in support of employees cost and fixed expenses. 8.1 The TPO and Commissioner of Income Tax have denied the capacity utilization adjustment on the ground that the assessee company is a captive unit of its AE. It is presumed that the orders/business are assured because the entire capacity created is for the purpose of business of the holding AE. The under utilization of the capacity can only be possible if the holding AE is not performing well. The fact that the assessee has increased the working capacity during the year has not been examined by the authorities below. The TPO and the Commissioner of Income Tax (Appeals) rejected the contentions of the assessee merely on the ground that the assessee is a captive unit of holding AE, therefore, the entire production capacity will be monitored and utilized by the holding company alone. The TPO and the Commissioner of Income Tax (Appeals) have erred in not examining the factual aspect of increase in output capacity before rejecting functional adjustment made to the PLI. The contention of the assessee is that it had increased the capacity in anticipation of new vistas. We do not concur with the view of Commissioner of Income Tax (Appea....
X X X X Extracts X X X X
X X X X Extracts X X X X
....so has to be allowed." 10. The Pune Bench of the Tribunal in the case of Tasty Bite Eatables Limited Vs. ACIT (supra) while dealing with the issue of capacity under utilization placed reliance on the decision of Mumbai Bench of the Tribunal in the case of ACIT Vs. M/s. Fiat India Pvt. Ltd. in ITA No. 1848/Mum/2009 decided on 30-04-2010 and in the case of Ariston Thermo India in ITA No. 1455/PN/2010 decided on 25-06-2013 and granted the benefit of low capacity utilization to the assessee. 11. The Delhi Bench of the Tribunal in the case of DCIT Vs. Claas India Pvt. Ltd. (supra) while dealing with the issue of capacity utilization in an elaborate manner bifurcated the issue in two parts i.e. capacity adjustment, allowable in whose hands and how to compute capacity adjustment under TNMM. The relevant extract of the order of Tribunal reads as under: "8. We have heard the rival submissions and perused the relevant material on record. Before embarking upon the question of allowability and extent of capacity adjustment under the TNMM, we want to make it clear that the assessee reduced its operating costs by considering its capacity utilization vis-à-vis that of compar....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) ; (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction." 9.2. Sub-clause (i) in the process of determination of the ALP under the TNMM talks of the computation of net operating profit margin realized by the assessee from an international transaction. Sub-clause (ii) is the computation of net operating profit margin realized by an unrelated enterprise from a comparable uncontrolled transaction. This refers to determining the operating profit margin of comparables with the same base as that of the assessee. Sub-clause (iii) provides that the net profit margin realized by a comparable company, determined as per sub-clause (ii) above, 'is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, ..... which could materially affect the amount of net profit margin in the open market.' It is this adjusted net profit margin ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e operating costs of the assessee in allowing the capacity adjustment. As against that, the correct course of action provided under the law is to adjust the operating costs of the comparable and their resultant operating profit. There is hardly need to accentuate that there can be no estoppel against the law. Once the law enjoins for doing a particular thing in a particular manner alone, it is not open to anyone to adopt a contrary or different approach. As the authorities below have adopted a course of action in allowing adjustment, which is not in consonance with law, we cannot approve the same. The impugned order is set aside and the matter is restored to the file of the TPO/AO for giving effect to the amount of idle capacity adjustment in the operating profit of the comparables and not the assessee. ii. How to compute capacity utilization adjustment under TNMM: - 10.1. Under the TNMM, the ALP of an international transaction is determined by computing and comparing the percentage of operating profit margin realized by the assessee with that of the comparables. We have noticed above that the difference in the capacity utilizations is an important factor, which needs t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....re at the same capacity utilization. There can be converse situation as well. Suppose the fixed costs incurred by a comparable (say, B) are Rs. 100 and it has capacity utilization of 25% as against the capacity utilization of 50% by the assessee. The above percentages show that the assessee has incurred full fixed costs at 50% of the utilization of its capacity, as against B incurring full fixed costs at 25% of the capacity utilization. This deciphers that the assessee has incurred relatively lower fixed costs and B has incurred higher costs. This difference in capacity utilizations can be eliminated by proportionately scaling down the fixed costs incurred by B so as to make it fully comparable. This we can do by reducing the fixed costs of B to Rs. 50 (Rs.100 into 25/50) as against the actually incurred fixed cost by it at Rs. 100. When we compute operating profit of B by substituting the fixed costs at Rs. 50 with the actually incurred at Rs. 100, it would mean that the fixed costs incurred by the assessee and B are at the same capacity utilization level. 10.3. Turning to the facts of the instant case, we find that both the TPO as well as the ld. CIT(A) have proceeded on....
X X X X Extracts X X X X
X X X X Extracts X X X X
....I Sofex Limited and Fortune Informatics Limited being loss making companies. The assessee has given the details of operating margin ratio earned by the aforesaid companies in the last 7 years which is as under: Financial Year Operating Margin Ratio (%) Fortune Informatics Ltd. F I Sofex Ltd. 2005-06 2.70 53.85 2004-05 (39.19) (25.69) 2003-04 (47.58) (120.13) 2002-03 47.63 (42.02) 2001-02 (20.83) 3.74 2000-01 6.45 4.35 1999-00 48.70 29.11 13.2 The contention of the assessee is that the said companies cannot be rejected merely on the ground that in a particular year, the companies have incurred losses. We find merit in the contention of the ld. AR of the assessee. A comparable can be rejected only if it is a consistent loss making company and the consistent loss making company is one which sustains losses in the three consecutive financial years. The Pune Bench of the Tribunal in the case of M/s. Bobst India Private Limited Vs. DCIT (supra) has held as under: "5.4 Further, we find in the case of Goldman Sachs (India) Securities Pvt. Ltd. vs. ACIT, which has....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... (P.) Ltd. reported as 354 ITR 586 concluded as under: "44. a. The mere fact that an entity makes high/extremely high profits/losses doesnot, ipso facto, lead to its exclusion from the list of comparables for the purposes of determination of ALP. In such circumstances, an enquiry under Rule 108(3) ought to be carried out, to determine as to whether the material differences between the assessee and the said entity can be eliminated. Unless such differences cannot be eliminated, the entity should be included as a comparable." 15. In the case of Cummins Turbo Technologies Limited Vs. DDIT (International Taxation) (supra) the Co-ordinate Bench of the Tribunal observed that where the assessee has taken super loss making companies in the list of comparables. The burden is on the TPO to prove that such comparable companies are consistent loss making companies. The relevant extract of the findings of Tribunal are as under: "14. We find that in respect of the selection of the comparables, the Tribunal has taken the consistent stand that as the super profit companies should not be included, the same way, super loss making companies should also be excluded. Though we agre....