TaxTMI 
TaxTMI 
2023 (3) TMI 1138
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.... law:- 2. (a) Selecting well established companies like Auto Ignition Limited, Chheda Electricals & Electronics Private Ltd. & Naina Semiconductors Ltd., unlike the assessee company, which is a start-up company. (b) In excluding the following companies, which are companies otherwise functionally comparable, from the list of comparable companies: i) Hind Rectifiers Ltd. ii) Continental Device India Private Limited iii) Incap Limited. (c) In not making working capital adjustment. (e) In disallowing reasonable adjustment for capacity utilization by the assessee company and comparable companies. (f) In Computing Operating Cost of the Assessee Company at Rs. 625,060,582 instead of actual cost of Rs. 623,698,587. (g) In incorrectly computing the operating profit margins of comparable companies. Corporate Grounds: 3. Disallowing the additions/ purchases made during the impugned year towards Building, Plant & Machinery totalling to INR 18,08,66,916/- and thus disallowing depreciation allowance u/s 32 thereon. 4. Without prejudice to the above ground, the disallowance of depreciation ....
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....o the directions of the DRP. 4. TP adjustment: 4.1 During the year, the assessee had the following international transactions. Particulars Received/Receivable Paid/Payable Method Purchase of raw materials - 6176,88,233/- TNMM Purchase of consumables - 65,75,973/- TNMM Purchase of stock in trade - 4851,87,275/- RPM Capital assets - 366,00,912/- TNMM Technical assistance Agreement - 80,28,464/- TNMM Technical assistance Fees - 34,06,055/- TNMM Reimbursement of expenses 196,41,038/- 3,43,066/- CUP 4.2 The assessee has adopted transaction net margin method as the most appropriate method and Operating Profit by operating Oncome is considering as the profit level indicator. The margin of the assessee in the manufacturing segment is as computed below. Particulars Manufacturing Segment Revenue From Operations 56,36,73,992/- Operating Income 59,22,15,934/- Operating Expenses 62,50,60,582/- Operating profit -3,28,44,648/- GP/Sales 20.45% OP/OR -5.55% 4.3 The assessee has chosen the following comparables and accordingly conclud....
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....lusion of Auto Ignition Limited, Chheda Electricals & Electronics Private Ltd. and Naina Semiconductors Ltd. 7. Auto Ignition Ltd. 7.1 The TPO did not accept the exclusion of this company for the reason that the assessee could not substantiate that brand value affects the profit margin. The TPO also held that the assessee has not raised any object with regard to the functional dissimilarity of the company. The DRP upheld the order of the TPO by stating that TNMM is robust enough to cater to variations such as capacity utilisation and that the assessee is not correct in seeking exclusion on the ground that the company has been in operation since 1971 and that cannot be compared with assessee who is in the first year of operation. 7.2 Before us, the Ld.AR submitted that Auto Ignition is a well-established company incorporated in 1971 and is in the business of manufacturing of auto electrical parts, which includes starter line motor and alternator,. The ld AR submitted that the company is manufacturing multiple products unlike assessee which is into two wheeler electrical components. It is also submitted that the company has Research & Development Dept. which have Admitted be....
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.... notes on fixed assets, copy of which is placed at pages 2351 of the paper book and is also into R&D activities unlike the assessee. In view of all these i.e., diversified business, export sale, incurring of expenditure on R&D activities and presence of intangibles, we are of the considered opinion that Auto Ignition cannot be considered as a comparable company. We, therefore, direct the A.O./TPO to exclude Auto Ignition from the list of comparables 8. Chheda Electricals & Electronics Private Ltd. 8.1 The TPO did not accept the exclusion of this company for the reason that the assessee could not substantiate that brand value affects the profit margin. The TPO also held that the assessee has not raised any object with regard to the functional dissimilarity of the company and that the company is functionally comparable. The DRP upheld the order of the TPO by stating that the assessee is not correct in seeking exclusion on the ground that the company has been in operation for a long time which does not mean that the company has better capacity utilisation than the assessee who is in the first year of operation. 8.2 The ld AR submitted that the Chheda Electricals is a well est....
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....l-VI) It manufactures components for production of semiconductors for all automobiles. R& D activities admittedly result in greater benefits. Whereas assessee is only manufacturing components utilized in two wheelers, and its sales were primarily to Hero Honda. Hence this is not a proper comparable.. 9.3 We heard the rival submissions and perused the material on record. We notice from the perusal of records that the company is manufacturing several electronic components such as Diodes, Thyristors, Triacs, Auto Diodes, Power Modules, Axial Lead Diodes, Bridge Rectifiers and Power Stacks/ Assemblies that are used in various types of automobiles. We notice that the assessee on the other hand is in the business of manufacturing electrical components for two wheelers such as like capacitor, Discharge Igniter CDI & Regular rectifiers. We further notice that Naina is having both export as well domestic turnover whereas in assessee's case there is only domestic sales in the manufacturing segment. Naina is into R&D activities unlike the assessee. In view of all these i.e., diversified business, export sale, and incurring of expenditure on R&D activities, we are of the considered opinion ....
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....) Securities Pvt. Ltd. vs. ACIT, which has been decided by ITAT, Mumbai 'K' Bench, wherein the TPO rejected Capital Trust as comparable because of two out of last three years taken into consideration. Capital Trust was in the red and not because the nature of business had any variance with that of the assessee. The Tribunal looked into the business segment of Capital Trust and found that in the foreign consultancy segment with which the Bench was concerned in the year 2004-05, it had operative profit / operative cost at 27.25%. Since the nature of services rendered by comparable were exactly on similar lines as that of the assessee, though, during the year, it was in the loss could not be disqualified as nonlegitimate comparable. The Tribunal drew strength from Brigade Global services (supra) for reaching this conclusion and held that the assessee had rightly taken Capital Trust as valid comparable and the Revenue authorities have erred in excluding the same. A similar view has been taken by ITAT, Mumbai 'K' Bench in the case of Temasek Holdings Advisors vs. DCIT. In sum and substance, all the above cases is that the company making persistent loss for past 3 years is not good compa....
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....making companies should also be excluded. Though we agree with the TPO that some of the comparables for the purpose of PLI adopted by the assessee are showing the loss, but the burden is on the TPO to prove where those companies are consistently loss making companies. Moreover, except unsupported reasoning, no data has been brought on record by the TPO for excluding the comparables selected by the assessee in the Transfer Pricing study report. We, therefore, find no justification to the adjustment made u/s.92CA(3) of the Act. We accordingly delete the same. In the result, relevant grounds are allowed." 16. Thus, in view of the fact that the comparables F I Sofex Limited and Fortune Informatics Limited although were having loss in the year of comparison but whether they were consistent loss making companies has not been ascertained by the TPO before rejecting the same. A company is said to be bad comparable if it is a consistent loss making entity. Accordingly, we are of the opinion that this issue needs a revisit to the Assessing Officer. The Assessing Officer after considering the submissions of the assessee and documents on record shall decide the issue afresh in the lig....
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....r fresh consideration in the light of the information available in public domain. Thus ground No. 7 is treated as allowed for statistical purposes." 12.3 We are of the view that identical directions would be just and sufficient in the present case hence the regarding inclusion of the aforesaid company as comparable company is hereby set aside to AO/TPO for fresh consideration. 13. Continental Device India Private Limited 13.1 TPO rejected this comparable company on the ground that it has brand value and R&D activities which makes the company functionally dissimilar and therefore rejected. The DRP upheld the same. 13.2 Before us the ld AR submitted that TPO/DRP contradicted its own finding in case of Auto Ignition. Ltd where the TPO rejected the claim of the assessee despite the company having comparable functional profile only on the ground that the company was doing research & development activities and had a brand value. The ld AR further submitted that since the primary ground for rejection is that Continental Device is carrying on R&D activities then for the very same reasons, Auto Ignition & Naina Semiconductor too must be excluded as comparables. 13.3 We heard ....
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....fit margin realised by the enterprise from an international transaction [or a specified domestic 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 account the differences, if any, between the international transaction [or the specified domestic 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 est....
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....") contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that wheri applying the arm's length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: • None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or • Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called "comparability adjustments. 3. In Paragraph 13 to 16 of the aforesaid OECD guidelines, need for working capital adjustment has been explained as follows: "13. In a co....
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....ifficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures. (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables. 15. In the present case the TPO allowed working capital adjustment accepting the calculation given s by the Assessee. The CIT(A) in exercise of his powers of enhancement held that no adjustment should be made to the profit margins on account of working capital differences between the tested party and the comparable companies for the following reasons: (i) The daily working capital levels of the tested party and....
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....AT in the case of ITO Vs. E Value Serve.com (2016) 75 taxmann.com 195(Del-Trib) has held that insisting on daily balances of working capital requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opening and closing working capital deployed. The Bench has also observed that that in Transfer Pricing Anal is there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. Therefore there is little merit in CIT(A)'s objection on working adjustment based on unavailable daily working capital requirements data. There is Also no merit in the objection of the CIT(A) regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines....
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....ing with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison. Therefore, the working capital adjustment as claimed by the Assessee should be allowed. We hold and direct accordingly." 14.2 In view of the above, we remit the issue to the file of AO/TPO to consider the working capital adjustment taking into consideration the details submitted by the assessee after allowing an opportunity of hearing to the assessee. It is ordered accordingly. 15. Ground no. 2(e) is with regard to denial of capacity utilisation. 15.1 The assessee had made an adjustment toward capacity utilisation on the ground that it is the first year of operation in the manufacturing segment. However, the TPO denied the same by stating that the capacity utilisation adjustment can only be made for comparable and not in the hands of the tested party. The DRP upheld the decision of the TPO. The Ld.AR submitted that the DRP incorrectly alleged that the assessee has not provided any documentary evidence to support of its claim. The DRP has not considered the fact that a certificate by management of the assessee company authenticating the utilized capaci....
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....9 & 10 are with regard to the capacity utilization adjustment. After hearing both the parties, similar issue came before this Tribunal in assessee's own case cited (supra) wherein it was held as under:- "12. On the issue of capacity adjustment, we find that the settled law is that adjustment on account of capacity utilization has to be granted. In this regard, the Tribunal in the case of IKA India has held as follows:- 22. We have heard the submissions of the assessee and the ld. DR on the issue raised by the assessee in ground No.7. We shall first see the statutory provisions relevant to the issue. Rule 10B(1)(e) of the Rules states that adjustments should be made to account for: "...the 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" 23. Rule 10B(2) of the Rules provides comparability of an international transaction with an uncontrolled transaction needs to be judged with reference to certain specified factors. One such factor is conditions prev....
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....ssumed), the contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties." Further, Para 2.74 of the OECD Guidelines while laying down the comparability criteria to be adopted while applying the transaction net margin method states as follows: "..... Thus where the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method' (Emphasis supplied) 25. US transfer pricing Regulations on this aspect is as follows:- In addition, the US transfer pricing regulations, u/s 482 of the Internal Revenue Code (hereinafter referred to as 'the US regulations') also support the above. Regulation 1.482-1(d)(2) of the US regulation states as follows: "In order to be considered comparable to a controlled transaction, an uncontrolled transaction need not be identical to the control....
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....utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment." (iii) In the case of Biesse Manufacturing Company Limited (IT(TP) A Nos. 97 & 493/Bang/2015) for AY 2010-11, the Tribunal held as follows: "10.4.1. We have heard the rival contentions and perused and carefully considered the submissions made and material on record; including the judicial pronouncements cited. The issue for consideration is whether adjustment for under-utilization of capacity is allowable in the case on hand and if so, the manner of computation thereof and the quantum of adjustment 10.4.5 In the above cited case of the Mumbai Tribunal i.e. Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity under-utilization can be granted Following the decision of the ITAT, Mumbai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment for capacity un....
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.... provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/transactions as per subclause (i) of rule 10B(1)(e) of the Rules itself. The absence of specific provision in Rule 10B(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been upheld in the following decisions:- * Capegemini India Pvt. Ltd. (ITA No.7861/Mum/2011) * Demang Cranes & Components (India) Pvt Ltd. [49 SOT 610 (Pune)] 30. As far as data of comparable companies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilization adjustment. 31. The assessee has under-utilized capacity during the subject AY and is accordingly factually and legally eligible ....
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....ty, * Actual Production in Units, * Break-up of Fixed Cost and Variable Cost; * Segmental/ product wise information, if any. 34. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No.7 is decided accordingly." 13. Accordingly, we set aside the issue to the files of the AO / TPO directing to follow the directions given in the case of IKA India (P.) Ltd. v. ACIT (supra)." 8.1. Respectfully following the above order of the Tribunal, we remit the issue to the file of AO/TPO on similar direction." 15.7 We notice that the assessee has submitted the workings for the capacity utilisation of for the manufacturing segment (page 725 paper book volume III). Considering the details furnished and respectfully following the above decision of the coordinate bench we remit the issue back to the AO/TPO with similar directions. Needless to say that the assessee be given a reasonable opportunity of being heard. It is ordered accordingly. 16. Ground no. 2(f) is with regard to TPO considering the incorrect operating co....