TaxTMI 
TaxTMI 
2023 (4) TMI 517
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.... on the assessee on the same date. Limitation to file this appeal expired on 20.06.2021. However, the appeal has been filed on 19.07.2021. Petition for condonation of delay is placed on record. It is stated that the period relating to delay falls during the time of Pandemic Covid-19. It is noted that the period of delay falls during the time of Pandemic of Covid-19 which has been excluded by the Hon'ble Supreme Court in the case of Suo moto Writ Petition (C) No. 3 of 2020 dated 10.01.2022 by which the period from 15.03.2020 to 28.02.2022 has been directed to be excluded for the purpose of limitation. Vide this order a further period of 90 days has been granted for providing the limitation from 01.03.2022. Accordingly, we condone the delay and proceed to adjudicate upon the matter. 5. Further, Ld. Counsel for the assessee stated that without prejudice to other grounds, the assessee is pressing ground nos. 2 and 3 relating to financial adjustments undertaken to eliminate material differences in respect of capacity utilization adjustment and working capital adjustment, respectively. The same is also stated in the written submission dated 11.10.2022 filed after the hearing held on 2....
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....s in the transaction of : 1. Purchase of components for assembly 2. Purchase of fixed assets/tools 3. Sale of assembled goods 6,37,22,701 6.2. Ld. CIT(A) while dismissing the appeal of the assessee held that assessee had started with the wrong assumption that only three of the nine comparables would qualify as comparables. This has not been accepted in appeal. In the rest of the working, no defect was found by Ld. CIT(A) in the working employed by the TPO and the same was confirmed while series of assumptions employed by the assessee in its working were not accepted in the appeal. Accordingly, working of TPO remained undisturbed, as held by the Ld. CIT(A). Aggrieved by the upward TP adjustments confirmed by the Ld. CIT(A), assessee is in appeal before the Tribunal. 6.3. Before the Tribunal, assessee has placed on record, paper books in two volumes containing 1005 pages in total along with written submission, summary of the two grounds of appeal i.e. ground nos. 2 and 3 and relevant extracts of Rule 10B of the Income Tax Rules, 1963 (hereinafter referred to as the "Rules") guidance note on transfer pricing regulations issued by Institute of Chartered Accountants of India (I....
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....ng of capital utilization adjustment furnished by the assessee, Ld. TPO observed as under: "(i) Capacity Utilisation risk not taken into account in the T P Report ii) Independent companies do not charge at premium rate to account for underutilization of capacity. iii) Non reflection of differences in utilization of infrastructure on pricing of independent comparables. iv) No evidence or reliable report to show that comparable companies' prices change with their capacity utilization rates or margin changes because of under utilization. v) The taxpayer submitted capacity workings as per which idle capacity was computed at 77.86% and as a result abnormal loss of Rs 4,77,88,098 was calculated in the TP Report by the Appellant. However, on perusal of fixed assets schedule, it was concluded that the assets were put to use during the year and full depreciation was claimed. vi) Fixed Asset Turnover Ratio considered to compare the capacity utilization of the Appellant and the comparables; vii) It is important for a manufacturing firm that uses significant plant and equipment in its operation to calculate Fixed Asset Turnover....
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....ded that the observation of the Ld. CIT(A) to link capacity utilization levels with price is without any base. On the observation of Ld. CIT(A) that the entire machinery of the assessee has been put to use for manufacturing process resulting in full claim of depreciation, Ld. Counsel contended that depreciation figures used in the tax audit report are governed by tax laws and is not indicative of the production made by using the said machineries. 7.4. In relation to ground no. 3 in respect of working capital adjustment made by the assessee to eliminate material differences for comparability, it was submitted that assessee being in the start-up phase, was operating with much lower levels of accounts receivables and inventory and higher levels of accounts payables. This implied that assessee did not have enough short term assets to cover its short term debts. It was submitted that levels of working capital have an impact on the prices charged and consequently the profits earned by a company. It would be against TP regulations and guidelines to compare the profits earned without making an economic adjustment in relation to the differences in working capital levels. To explain the r....
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....zation adjustment stated in para 9. It was contended that through the use of FATR, Ld. TPO has considered, both the capacity utilization adjustment and working capital level adjustment together and such an application is not erroneous. It was also contended that the brand value of the AE of the assessee does not warrant any capacity utilization adjustment on the contention of the assessee that in the first year of operations in automotive sector, manufacture customer would not entrust significant volumes to a new vendor unless it is satisfied with a price and quality of the products supplied by the vendor. 10. We have heard the rival contentions and perused the material available on record and gone through the submissions made. Before embarking upon deciding the two issues before us, it is more appropriate to understand the relevant regulations and guidelines which need to be borne in mind. Rule 10B of the Rules deals with determination of arm's length price u/s. 92C of the Act. MAM in the present case is TNMM which is not in dispute. We also note that assessee has been selected as the tested party which is also not in dispute. 10.1. The relevant extract from Rule 10B is as u....
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....ical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction [or a specified domestic transaction] shall be the data relating to the financial year [(hereafter in this rule and in rule 10CA referred to as the 'current year')] in which the international transaction [or the specified domestic transaction] has been entered into : Provided that data relatin....
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....king capital have an impact on the prices charged and the profits earned by a company. In respect of the above two adjustments, we note that it would be against the TP regulations and guidelines enumerated above to compare the profits earned without making these economic adjustments. 13. From rule 10B(3)(ii) of the Rules, we note that an uncontrolled transaction is considered to be comparable if none of the differences are likely to materially affect the price or cost charged or the profit arising therefrom in the open market or if reasonable accurate adjustment can be made to eliminate the material effect of such differences, if they so exist. Thus, it is reasonable to infer from the said rule that the purpose or intent of the comparability analysis is to examine as to whether or not values stated for the international transactions are at arm's length i.e. whether the price charged is comparable to the price charged under an uncontrolled transaction of similar nature. The position that emerges under the regulation is that if there are differences which can be adjusted, then adjustments are required to be made and also that if the differences between the companies are so materia....
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....ent 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)] ... 31. The assessee has under-utilized capacity during the subject AY and is accordingly factually and legally eligible to an adjustment for the same. Therefore, such a benefit cannot be denied to the assessee only for the reason that the data about comparable companies is not available. Requiring the assessee to produce such a data which is not available in public domain would tantamount to requiring the Appellant to perform an impossible task. The only way to get the data in the current case, would be where the TPO collates the same from the comparable companies by exercising his powers under section 133(6) of the Act. 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.' ... The position in India as per Indian regulations on the subjec....
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....that the settled law is that adjustment on account of capacity utilization has to be granted. In this regard, the TPO is bound to exercise its powers under section 133(6) of the Act and to collate the information on capacity details of comparable companies, such as actual capacity in units, installed capacity, breakup of affixed and variable cost, product wise segmental profitability (if any) and provide the assessee opportunity by sharing the details so obtained on the comparable companies. The Tribunal also held that if there is want of information / data, adjustment can be made to the tested party also. In this regard, reference may be made to the decision of the ITAT Bengaluru Bench in the case of Flint Group India Pvt. Ltd., IT(TP) No.3285/Bang/2018 dated 31.10.2019. We are of the view that in the given facts and circumstances of the case, it would be just and appropriate to set aside the impugned order on this issue and remand the issue to the AO / TPO to carry out the exercise of allowing adjustment on account of underutilized capacity. We also find that the assesssee's objection with regard to not allowing working capital adjustment has been rejected by the DRP but the ....
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....it fit and proper to remit this matter to the file of the Transfer Pricing Officer for fresh adjudication in the light of our above observations and particularly dealing with the contention that the present year being first full year of operations, the appellant was forced to have higher import content in raw material as the manufacturing facilities, and vendor development, was not complete, as also dealing with the contention that the business model in this year of operation was fundamentally different from the business model of the comparable concerns." 15.4. Calsonic Kansel Matherson Products Ltd. v. Deputy Commissioner of Income-tax, Circle 5(2), New Delhi [2016] 72 taxmann.com 109 (Delhi - Trib.) "11. We have considered the submissions of both the parties and have perused the record of the case. Ld. DRP in principle has accepted that adjustment on account of capacity utilization is to be allowed to appellant. However, in the absence of non- availability of item wise expenses, in the case of comparable companies, restricted the adjustment only to depreciation. In 'our opinion, this is not the correct approach because unutilized capacity has direct bearing on the....
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....ete year of operation. Accordingly, the appellant is entitled to the adjustment on account of capacity under-utilization. The Pune Bench of Tribunal in Tasty Bite Eatables Ltd's case (supra) has already allowed similar adjustment and accordingly, we hold that the same is to be allowed in the hands of appellant. Accordingly, we delete the proposed addition on account of non-allowable adjustment for capacity underutilization at RS.1.44 crores." 15.6. Amdocs Business Services Pvt. ltd. Vs. Dy. Commissioner of Income-tax, Cir.1(1), Pune [ITA No. 1412/PN/ll]- Pune ITAT. "9. The next major point made out by the appellant is that this being the first full year of operation, the appellant had incurred certain expenditure which are start-up costs and cannot be fully recovered in the instant year itself, and such an expenditure has abnormally affected the profit margin. It is also canvassed that due to the start-up year the capacity utilization was not satisfactory, whereas its profitability has been benchmarked against 13 comparables which are established entities and have been set up over the years. The plea set-up by the appellant for economic adjustments on account of und....
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....ed the relevant transfer pricing guidelines as well as transfer pricing regulations, it was held by the Id. ClT(A) that various adjustments made by the appellant were reasonable and accurate. He also held that the said material difference were arbitrarily ignored by the TPO while disallowing the appellant's claim such for adjustments and there being no proper reasons assigned by him for ignoring the said difference, the transfer pricing exercise done by him in the report was entirely futile. At the time of hearing before us, the Ld. DR has not been able to raise any material contention to rebut/controvert the observations/finding recorded by the Ld. ClT(A) in his impugned order to arrive at the said conclusion. He has simply relied on the report of the transfer pricing officer in support of the Revenue's case. However, as pointed out by the Ld. Counsel for the appellant from the copies of relevant reports, the TPO himself has allowed similar adjustments made by the appellant in the immediately proceeding years i.e. A. Y. 2002-03, 2003-04 as well as in the immediately succeeding years i.e. 2005-06 and 2006-07 wherein the facts involved were similar to that of the year under ....
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....e for the purpose of allowing adjustments towards capacity utilization and working capital levels, the only way to get the data in a current case would be by Ld. TPO collecting the same from the comparable companies so selected by him by exercising his powers u/s 133(6) of the Act. For this proposition, reliance is placed on the decision of Coordinate bench of ITAT, Mumbai in the case of Kiara Jewellery Pvt. Ltd. in ITA No. 8109/Mum/2011 wherein the TPO/AO was directed to obtain the exact details on capacity utilization of comparable companies, if not available in public domain. The relevant extract of the aforesaid decision is as under: "11. Keeping in view the decision of the Tribunal in the case of Petro Araldite (P) Ltd. (supra) laying down the guidelines on the issue of capacity utilization, we consider it appropriate to restore this issue relating to adjustment on account of capacity utilization in the case of assessee company to the file of AO/TPO for deciding the same afresh keeping in view the said guidelines. If the exact details of capacity utilization of the comparable companies are not available in the public domain, the AO/TPO is directed to obtain the same d....
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....hereas all the figures used by the Appellant were sourced from audited financial statements of the respective companies. That on the facts and in the circumstances of the case, the Ld. TPO, Ld. AO and Ld. CIT(A) erred in law and in facts by quashing the approach taken for computing capacity utilisation by the Appellant and adopting Fixed Asset Turnover Ratio for calculating the same, which does not give the true picture of a company's capacity utilisation. 3. Non-allowance of financial adjustments undertaken to eliminate material differences - working capital adjustment 3.1 That on the facts and in the circumstances of the case, the Ld. TPO, Ld. AO and Ld. CIT(A) erred in law and on facts in not allowing the working capital adjustment to account for, inter alia, differences in the working capital position of the Appellant and the comparable companies. Document 2 4. Non-consideration of transactional level information and benchmarking submitted for purchase of fixed assets 4.1 Without prejudice to Grounds 2 and 3, that on the facts and circumstances, the Ld. TPO and Ld. AO erred in facts and in law in not considering the nature of the t....
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....y approach undertaken by the Appellant. 7. Initiation of penalty proceedings 7.1 That on the facts and in the circumstances of the case, the Ld. AO has erred in initiating penalty proceedings under section 271(1) (c) of the Act. The appellant craves leave to add/alter/amend/substitute any of the above grounds of appeal, at the time, before or at the time of hearing of the appeal, so as to enable the Appellate authority to decide this appeal according to law. Document 4 Name of comparable Utilisation from audited financials Average utilisation Comparables selected by Appellant Avtec Limited 48% Federal-Mogul Goetze (India) Ltd. 83% 81% KAR Mobiles Ltd. 91% Kalyani Forge Ltd. 100% Comparables selected by Ld. TPO Hindustan Hardy Spicer Ltd Simmonds Marshal Ltd Uni Klinger Ltd Average of both Profit Analysis of Witzenmann India 42% 67% 72% 100 %, 95%, 59% 71% Particulars Sales Amount in INR Amount in INR Financial Year Ended 31st March 2009 Financial Year Ended 31st March 2009 Amount in INE Financial Year Ended 31st March 2009 Assembling 11,16,64,715 ....
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....1,685 Variable Electric Charges 3,07,053 3,07,053 Fixed Fooding & Lodging (Relating to 10,84,978 10,84,978 Variable Travelling) Freight & Carriage (Out Ward) 5,18,908 5,18,908.00 Fixed General Charges 3,20,022 3,20,022 Fixed Discount Allowed Insurance 24,256 24,256 Variable 4,92,006 4,92,006 Fixed Internet Expenses 1,26,694 1,26,694 Fixed Interview Call Expenses Variable Legal & Professional Charges 4,73,959 4,73,959 Fixed Membership Subscription 19,700 19,700 Fixed Office Maintenance 5,01,539 5,01,539 Fixed Others Repairs 29,909 29,909 Variable Packing & Forwarding 42,404 42,404 Variable Postage & Telegram 1,155 1,155 Variable Printing & Stationery 2,70,745 1,35,373 1,35,373 F50%V50% Provision for Bad Debts Variable Profession Tax-Company Rates & Taxes 2,500 57,195 2,500 Fixed 57,195 Variable Rent (Flat - Chennai) 14,10,000 14,10,000 Fixed Rent (Office- Kolkata) 4,63,320 4,63,320 Fixed Repairs & Maintenance (General) 2,117 1,059 1,059 F50% V50% Repairs to R....
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....7,85,74,609 Non-AE 8,64,82,899 8,64,82,899 8,64,82,899 8,64,82,899 Adjustment (4,77,88,098) (4,77,88,098) (4,77,88,098) (4,77,88,098) Total Cost 11,40,30,697 11,35,27,762 10,97,86,114 11,72,69,410 Operating Profit 14,00,370 19,03,305 56,44,953 (18,38,343) Net Profit Margin (%) 1.21 1.65 4.89 -1.59 Comparable Margin 5.32 Less: Working Capital Adjustment 3.67 Comparable Margin after adjustment 1.65 Document 8 a) Identify differences in the levels of working capital. Generally, trade receivables, inventory and trade payables are the three accounts considered. If the appropriate base is sales for computation of margin, for example, then any differences in working capital levels should be measured relative to sales. Document 9 b) Calculate a value for differences in levels of working capital between the tested party (in this case the appellant) and the comparables relative to the appropriate base and reflecting the time value of money by use of an appropriate interest rate (Prime Lending Rate for AY 09-10). c) Adjust the result to reflect differences in levels of working ca....
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.... [PLR x (Working Capital/Sales of Appellant - working capital/Sales of comparable companies)] = (5.28%) A final summary of the above comparables is provided below: Sl. No. Company Name 1 2 3 Hindustan Hardy Spicer Ltd Simmonds Marshal Ltd Uni klinger Ltd Average Adjusted OP/Sales Adjusted OP/TC -5.28% -5.13% 5.33% 6.73% 1.08% 1.59% -0.38% 1.06% Document 11 6.42... TNMM may be considered as the most appropriate method, subject to other parameters such as degree of comparability, comparability factors, functional profile, etc. 6.43 However, this should not be construed as TNMM being a residual method or method of last resort. Though, TNMM is more tolerant to differences in the product comparability as compared to the traditional methods, the comparability standard to be applied to the TNMM requires a high degree of similarity in several factors between the tested party and the independent enterprises that may adversely affect the net margins. For example: contractual terms and conditions, functions performed, risks assumed and assets employed, pricing mechanism, availability of the comparable data, etc....
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....dingly, where the international transaction/ specified domestic transaction does not have certain characteristics that are present in the uncontrolled transaction, the value of these characteristics has to be computed and included in the value of the international transaction/specified domestic transaction. Some common adjustments that are carried out to achieve the above are: Working capital adjustment Risk adjustment Idle capacity adjustment/Start-up cost adjustment Depreciation adjustment (emphasis added) Document 12 2.76 The use of net profit indicators can potentially introduce a greater element of volatility into the determination of transfer prices for two reasons. First, net profit indicators can be influenced by some factors that do not have an effect (or have a less substantial or direct effect) on gross margins and prices, because of the potential for variation of operating expenses across enterprises. Second, net profit indicators can be influenced by some of the same factors, such as competitive position, that can influence price and gross margins, but the effect of these factors may not be as readily eliminated. In the traditional....