AI Drafter 
TaxTMI 
TaxTMI 
2019 (2) TMI 2023
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....on with its AE in the form of import of raw materials, finished goods & capital goods; receipt of services; reimbursement of expenses and export of finished goods. The dispute herein is with regard to the ALP adjustment made in respect of export of finished goods (referred as "manufacturing segment"). The assessee had adopted TNMM method as most appropriate method and operating profit margin to sales ratio as PLI. 3. The OP/Sales in the manufacture segment before depreciation was computed at (-) 12.70% . The company had selected four comparables, whose average PLI was computed at 9.23%. However, in the TP Study, the assessee recomputed the average margin of comparable by excluding "depreciation" and "overheads". Similarly it also re-computed its own margin in the same way. The Ld A.R explained the rationale behind the above said claim of the assessee. It was submitted that the capacity utilization of the assessee was lower during the year under consideration. Irrespective of the capacity utilization, it had to incur overheads and provide for depreciation and both these expenses have reduced its profit margin. It was submitted that the comparable companies had higher capacity uti....
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....hi-Trib.)], wherein also it was held that adjustment for the difference in capacity utilization is required to be made to iron out the difference. The learned AR submitted that the Delhi Bench of the Tribunal, in the above said case, has also held that the capacity adjustment should be made in the hands of comparable companies and has also explained as to how the capacity utilization adjustment is required to be made. Accordingly, the learned AR prayed that the adjustment towards difference in capacity utilization be allowed. 6. The learned Departmental Representative, on the contrary, supported the order passed by the learned CIT(A). 7. We heard the parties and perused the record. We noticed that the Hon'ble Bombay High Court in the case of Petro Araldite (P.) Ltd. (supra) and the Delhi Bench of the Tribunal in the case of Claas India (P.) Ltd. (supra) have held that the adjustment towards difference in capacity utilization is required to be made in terms of Rule 10B(1)(e)(iii) of the Income-tax Rules. In the instant case, it is the submission of the assessee that the average capacity utilization achieved by it during the year under consideration was 42%, while the capaci....
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....his capacity utilization adjustment, he determined OP/TC of the assessee at a loss of (-) 7.78%. Total cost of the assessee was taken at Rs.36.88 crore. By applying the arithmetic mean of the profit rate of comparable companies chosen by him at 11.92%, he proposed a transfer pricing adjustment of Rs.7,26,60,103/-, for which addition was made by the AO. The ld. CIT(A) accepted the assessee's contention about not making any TP adjustment in relation to non- AE transactions. The Revenue is not aggrieved to that extent. As regards adjustment for capacity utilization, the ld. CIT(A), by considering the companies finally held by him as comparable, applied the factor of 29/46 for reducing the operating costs actually incurred by the assessee. Apart from the adjustments allowed by the TPO on Administration expenses and Depreciation, the ld. CIT(A) also reduced Advertisement & Marketing expenses, Employee cost (by taking entire employee cost, other than bonus, at Rs.35515709 as fixed). The Revenue is aggrieved against the allowing of capacity utilization adjustment to this extent by the ld. CIT(A). 8. We have heard the rival submissions and perused the relevant material on record. ....
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.... differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; (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 i....
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....unt of differences with the comparable uncontrolled transactions. The adjustment, if any, is required to be made only in the profit margins of the comparables. 9.4. Reverting to the facts of the instant case, we find that the authorities below have adjusted the 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, t....
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....osts of A to Rs. 200 (Rs.100 into 50/25) as against the actually incurred fixed costs by it at Rs.100. When we compute operating profit of A by substituting the fixed costs at Rs.200 with the actually incurred at Rs.100, it would mean that the fixed costs incurred by the assessee and A are 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 cost....