TMI Blog2011 (9) TMI 562X X X X Extracts X X X X X X X X Extracts X X X X ..... 16% to 55.41%. According to the TPO, the assessee has not been able to substantiate that the labour is of a fixed nature only. Further, according to the TPO, the AE should have compensated the assessee for excess labour due to its inability to give substantial work to it. - held that:- When regular employees are working with an assessee, he cannot terminate their services because of lesser capacity utilization during the year. The utilization of capacity during the year depends on various factors, the main factor being receiving orders from overseas and other clients. Further, the orders also should be acceptable to the assessee considering the profitability. - the adjustment of Rs. 3,25,92,361/- is uncalled for and accordingly directed to be deleted. - Decided in favor of assessee. - IT Appeal Nos. 2043 and 8187 (Mum.) of 2010 - - - Dated:- 9-9-2011 - N.V. Vasudevan, R.K. Panda, JJ. K. Gopal for the Appellant. Goli Sriniwas Rao for the Respondent. ORDER R.K. Panda, Accountant Member ITA No. 2043/Mum/2010 filed by the Revenue is directed against the order dated 14.12.2009 passed by the CIT(A)-15, Mumbai relating to Assessment Year 2005-06. ITA No. 8187/Mum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the TPO's order) :- (a) Change in Product Mix: In this year the diamonds processed has increased from 64239 pieces to 67161 pieces. However due to shortage of rough stones, the large stones on which processing charge is more (USD 35) constitutes only 59.08% of the total stones processed compared to 84.15% in the preceeding year. The rate of processing on these stones is USD 35 equivalent to Rs. 1600/- at average rate of Rs. 45.70 per dollar while total cost to the assessee is Rs. 945/- per piece giving a margin of Rs. 655/- per stone. This year the assessee has received more stones of USD 20 category. It constitutes 34.74% of total stones compared to 0.61% in the earlier year. The processing charge on such stones is USD 20 equivalent to Rs. 914/- at average rate of Rs. 45.70 per dollar while total cost to the assessee is Rs. 505/- per piece giving a margin of Rs. 409/- per stone. Therefore, it is stated that the loss due to shortage in rough diamonds and change in product mix has resulted in a loss of Rs. 2.59 cr. The assessee has submitted letter from the A.E. and other evidences in support of shortage of rough diamonds. (b) Due to difference in exchange rat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee company submitted without prejudice that it is eligible for deduction u/s. 10B of the I.T. Act and filed detailed submissions explaining that it is eligible for deduction u/s.10B. It was further submitted that due to negative income Form No.56 was not filed along with the return of income and hence no exemption u/s.10B has been claimed at the time of filing of the return. It is only due to the additions/disallowances made in the assessment, the income has become positive and therefore, the assessee has filed Form No.56 G. 4.1 The AO accepted the above contention of the assessee. After making addition of Rs. 4.25 crores on account of T.P. adjustment, and certain other additions (which are not the issue before us), the AO arrived at the business income at Rs. 3,95,02,697/-. After allowing exemption u/s.10B for the above amount, the AO determined the business income at NIL. 5. The assessee challenged the T.P. adjustment of Rs. 4.25 crores before the Ld. CIT(A). Detailed submissions were made and arguments advanced. It was submitted that transfer pricing study was carried out by the assessee for the first time for the Assessment Year 2003-04. It was concluded in para 1.8 of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bmissions made by the assessee were accepted by the TPO-IV and the transactions were considered to be at Arms Length for Assessment Year 2004-05 also. Hence no adjustment was made. 6. It was submitted that the TPO deviated from the T.P. orders of earlier years and made adjustment of Rs. 4.25 crores in an arbitrary manner. It was submitted that the assessee continued its business in similar manner as in earlier years. Some of the factors which adversely affected the financial performances of the company, were highlighted which are as under :- (i) Heavy shortage of high quality rough stone persisted through the year. As a result, the revenues fell to Rs. 759.99 lacs as against Rs. 1019.03 lacs. A fall of 25.42% for Rs. 259.04 lacs. (ii) Due to non-availability of high quality rough stone, the product mix changed drastically. The USD 35 category which accounted for 84.15% of the total revenues during the previous year fell to 59.08% during the year under appeal. The other low quality category of USD 20 rose and accounted for revenues of 34.74% during the year under appeal as against 0.61% during the previous year. (iii) The overall expenses (excl. depreciation) have increase ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arlance. Increase in total labour cost over a period cannot be compared with the sales prices charged. It was submitted that the TPO has strangely chosen to compare the increase in total labour cost with the processing charges charged per piece. If at all a comparison was necessary it was only appropriate that the cost of processing per piece be compared to the processing charges charged per piece. The detailed working submitted by the assessee at the time of proceedings clearly shows that the labour cost of processing one piece of diamond (USD 35 category) is Rs. 329/- per piece as compared to Rs. 326/- per piece in the earlier year. 6.3 It was argued that making an adjustment by comparing the increase in total cost of labour over a period of one year with the processing charges charged is absolutely irrelevant. It was further contended that adjustment made to the current years revenues by taking the last years labour cost to revenue ratio, was improper, absurd, without any justification and liable to be set aside. Moreover, it was stated that the assessee company has not been formed with the intention of providing services to related companies only. It was submitted that a peru ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h ratio. This omission makes the whole exercise inherently flawed. The TPO assumes that since the personnel (labour) cost has gone up, it should ipso facto lead to increased in processing income. Since that has not happened he has carried an adhoc adjustment in a whimsical manner. The TPO also erred in comparing the increase in total labour cost with processing charges per piece. If at all the comparison was necessary it should be that the cost of processing per piece be compared to the processing charges levied per piece. This would have been a direct and straight comparison. From the working submitted by the appellant, it is evident that labour and cost of processing one piece of diamond (USD 35 category) is Rs. 329/- per piece as compared to Rs. 326/- per piece in the earlier year. Thus, the appellant has charged Rs. 3/-more then that in the previous year. It is a fact that labour costs generally increase at least by 10% from the earlier year and it may or may not result in corresponding higher sales. This crucial aspect of business and commerce has been over looked by the TPO. If revenues were invariably to increase in direct proportion to labour costs then all businesses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t has been held that the ultimate profit or loss of the tax payer is not a relevant factor for exercise. It is not out of place to mention here that the appellants transaction with AE for Assessment Year 2003-04 and 2004-05 after undergoing TPO's scrutiny were held to be Arms Length demonstrating confidence in Compliance System's and processes of the appellant. Further, the appellant being a 10 A unit has got no incentive for generating loss as even its profits are exempt from tax. Taking all the facts and circumstances of the case, I hold that there is no ground for any adjustment and assessees price is held to be at Arms Length. Thus the addition of Rs. 4,25,00,000/- is deleted." 8. Aggrieved with such order of the Ld. CIT(A), the Revenue is in appeal before us. 9. We have considered the rival submissions made by both the sides, perused the orders of the authorities below and the paper book filed on behalf of the assessee. There is no dispute to the fact that the assessee's T.P. study was accepted by the TPO in the Assessment Years 2003-04 and 2004-05 and the transactions with the AE's were held to be at arm's length. We find the assessee during the impugned assessment year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... histicated machineries, increasing the capacity of processing and increasing the labour component it had earned Rs. 7.85 crores as processing charges for processing 60,289 diamonds. The labour cost constitutes 61% of the total revenue and the operating margin is around 6%. Further the assessee had not increased the rate of processing, although the labour expenses have gone up. He, therefore, asked the assessee to show cause as to why appropriate adjustments shall not be carried out. 11.1 The assessee vide its reply dated 23.10.2009 filed explanation, the details of which are as under :- 1. The labour costs is fixed in nature and due to the lower utilization of the capacity, the labour had to be kept idle which has resulted in a higher incident of labour in relation to the revenue. After considering a rebate for lower utilization of capacity the gross profit margin would come to around 43.54%. 2. The per unit rate charged by the assessee is around Rs. 3700 per carat as against the market rate of around Rs. 500 per carat and therefore, the pricing is at arm's length. 3. Due to poor market condition and lower supply of the diamonds by the AE, the assessee could not proce ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee has not been able to substantiate that the labour is of a fixed nature only. Even otherwise the AE should have compensated the assessee for excess labour, due to its inability to give substantiate work to its AE keeping the base year 2004-05 when a proper bench marking had been carried out. The assessee should have at least recovered enough processing charge to recover the excess labour. According to the TPO, the incidence of labour in Assessment Year 2004-05 was 39.16% on the total income of Rs. 10.19 crores. As against the same labour cost is Rs. 4.35 crores on total receipts of Rs. 7.85 crores in the current year i.e. 55.41%. Applying the benchmark rate of Assessment Year 2004-05, the processing charges received during the year according to him should have been Rs. 11,11,34,937 {(7,85,42,576/39.16) x 55.41} against the actual amount received of Rs. 7,85,42,576/-. He accordingly made an adjustment of Rs. 3,25,92,361/-. He further noted that the assessee shall not be entitled to any exemption under Section 10A of the Income Tax Act, in respect of the above adjustment in view of the specific provisions of Section 92C(4) read with first proviso thereto. 13. During the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mination of the ALP for the Assessment Year 2006-07. The Ld. Counsel for the assessee submitted that the assessee has given the method of pricing. However, the method has not been questioned by the TPO. Referring to pg. no. 10 of the paper book, he drew the attention of the bench to the details of purchase of consumer goods from the AE. Referring to pg. no. 11 and 12 of the paper book, he drew the attention of the bench to the income from processing, where the method used for determining the ALP has been mentioned as (Cost +). Similarly referring to pg. no. 13 of the paper book, he drew the attention of the bench to the purchase of laser machine and measuring equipment from the AE and the TNMM method used for determining the ALP. Referring to pg. no. 14 of the paper book, he drew the attention of the bench to the interest paid on external commercial borrowing from the AE and the CUP method used for determining the ALP. Referring to pg. no. 15 and 16 of the paper book, he drew the attention of the bench to the recovery of freight expenses incurred from the AE, where the method used for determining the ALP has been mentioned as 'CUP' Method. Referring to pg. no. 52 of the paper book, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... circumstances enumerated in clauses (a) to (d) of that sub-section and in the event of material information or document in his possession on the basis of which an opinion can be formed that any such circumstance exists. In all other cases, the value of the international transaction should be accepted without further scrutiny." 15.1 He submitted that the TPO had no material information or document to contradict the various submissions made by the assessee. The adjustment was purely whimsical and based on presumptions and submissions. He accordingly, submitted that the adjustment made by the TPO should be deleted and the return of the assessee should be accepted. 16. The Ld. DR on the other hand, referring to pg. no. 58 of the paper book submitted that as against operating profit of 44.40% in Assessment Year 2003-04 and 26.90% in Assessment Year 2004-05, the operating profit has declined to 6.01% for the Assessment Year 2006-07. The problem started because of down fall in the operating profit. Referring to the decision of Bangalore Special Bench of the Tribunal in the case of Aztec Software Technology Services Ltd.'s case (supra), he submitted that selection of most appropriat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6% to 55.41%. According to the TPO, the assessee has not been able to substantiate that the labour is of a fixed nature only. Further, according to the TPO, the AE should have compensated the assessee for excess labour due to its inability to give substantial work to it. However, we do not find any sound reason for adjustment of ALP on this account. We find force in the submission of the ld. Counsel for the assessee that the increase in labour cost during the year is hardly 10 to 12% as compared to the preceding year which is due to annual increment of salary etc. When regular employees are working with an assessee, he cannot terminate their services because of lesser capacity utilization during the year. The utilization of capacity during the year depends on various factors, the main factor being receiving orders from overseas and other clients. Further, the orders also should be acceptable to the assessee considering the profitability. Similarly getting work order from others, especially in diamond industry, also depends on various factors such as demand in market due to customer's choice etc. We also do not find any sound reason on the logic of the TPO that the AE should have co ..... X X X X Extracts X X X X X X X X Extracts X X X X
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