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TMI Blog2013 (12) TMI 140X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee is with regard to the transfer pricing adjustment of Rs. 5.34 crores made by the Transfer Pricing Officer (TPO); ii) The second issue relates to disallowance under section 14A of the Act; and iii) The third issue relates to charging of interest under section 234B. 3. With regard to the transfer pricing adjustment, the assessee has raised as many as twelve sub-grounds challenging the various aspects regarding the adjustment made by the TPO and confirmed by the DRP. 4. Facts in brief:- The assessee is an export oriented unit which is engaged in the business of manufacturing assembling and testing of Switch Mode Power Supplies (for short "SMPS") used in the computer networking devices. All its international transactions during the year relates to import of raw materials, consumables and export of SMPS and import of fixed assets with its A.Es. In the transfer pricing study report, following international transactions have been reported. Sr. no. Name of the A.E. Nature of International Transaction Amount (in crores) Method Used 1 Quality Components & Systems Pte Ltd., Singapore Import of raw material, consumables, etc. 52.61 CPM 2 Q.C. Systems Inc., USA Import ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een approved by the DRP, therefore, there is no infirmity in the said order. In any case, he submitted that if required the matter can be set aside to the file of the DRP for fresh adjudication. 8. We have heard the rival contentions, perused the findings of the authorities below and the material placed on record. On a perusal of the detail objections made by the assessee before the DRP and also various documents which have been place in the paper book, it is seen that the DRP has failed to consider or examine the assessee's contention not only on the issue of adjustment of low capacity utilization but also on determination of PLI by the TPO. The assessee has also raised objections with regard to certain comparables. All these objections and submissions have been brushed aside without any proper adjudication on the objections and assigning any reasons. The relevant points raised on behalf of the assessee do not find any mention or proper discussion in DRP's direction which it is obliged to do so. The DRP is a quasi judicial authority and when dealing with a lis pending before it, it is obligatory on its part to ascribe cogent reasons as to why the assessee's contentions are not ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the A.E., the TPO has applied CUP method as against CPM applied by the assessee and made an adjustment of Rs. 3,99,075. 11. Before the DRP, the assessee made specific objections and also made a detail rebuttal of the observations made by the TPO on capacity utilization. However, the DRP confirmed the TPO's observation and rejected the assessee's entire objection. 12. Before us, the learned Counsel for the assessee submitted that the annual license capacity and annual installed capacity of assessee's production was 17.00 lakhs in the assessment years 2005-06 and 2006-07. The same annual capacity continues in this year also. However, by mistake, in the annual accounts, the assessee's annual license capacity and annual installed capacity have been mentioned at Rs. 4 lakhs which in fact should have been Rs. 17 lakhs as was there in the earlier years. As against the annual capacity, the assessee has utilized only 20.22%. Therefore, while making a comparison with the comparable companies, adjustment on account of capacity utilization has to be made. In support of his contention about the installed capacity, the learned Counsel for the assessee submitted that fresh evidences were filed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the assessee will produce all the necessary evidences to show what is its correct annual capacity and actual capacity utilization. The Assessing Officer, after verifying the same, will accordingly deal with the issue of adjustment on account of capacity utilization and other contentions raised by the assessee. While doing so, the Assessing Officer may also consider the ratio and principle laid down by the Tribunal in M/s. Petro Araldite Pvt. Ltd. (supra), wherein it has been observed and held as under:- "Adjustment for the capacity utilization. 19. There being difference in the capacity utilization of the assessee vis-à-vis the comparables, adjustment on account of capacity utilization was claimed by the assessee. According to the assessee, if the profit margin is taken before depreciation by adopting Earning Before Depreciation, Interest and Tax (EBDIT) as PLI, the effect of difference in capacity utilization on profit margin can be nullified. The TPO did not approve this method adopted by the assessee for making adjustment on account of capacity utilization whereas the ld. CIT(A) found the same to be acceptable holding that the under utilization of capacity results in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce in capacity utilization affects the profit margin and how the adjustment on account of difference in capacity utilization can appropriately be made within the frame-work of Rule 10B. The issue of difference in capacity utilisation generally comes in the case of manufacturing concern and like any other business undertaking, the manufacturing concern has mainly two types of overheads i.e. fixed overheads and variable overheads. The variable overheads vary in proportion to the sales and they therefore do not have any effect on the profit margin as a result of difference in capacity utilization. The fixed overheads, on the other hand, do not vary with the volume of sales and since they remain by and large static irrespective of level of capacity utilization, the profit margin gets affected as a result of difference in capacity utilization on this count. The under utilization of capacity results in over allocation or over absorption of fixed overheads resulting into under-recovery of fixed overheads which adversely affects the profit margin. As the level of capacity utilization goes up, the rate of allocation or absorption of fixed overheads to sales comes down resulting into higher ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as PLI instead of EBIT. We are unable to concur with this view of the ld. CIT(A). In our opinion, when the PLI is taken as OP to sales or OP to cost, operating profit of the assessee as well as comparable cases becomes relevant and the depreciation being very much integral part of the operating expenses of the manufacturing concern, the same cannot be excluded for the purpose of computing operating profit. Moreover, clause (e)(i) of sub Rule (1) of Rule 10-B requires that the net profit margin of the assessee is to be worked out while clause (e)(ii) of the said sub Rule requires that net profit margin of the comparables is worked out. Clause (e)(iii), which permits the adjustments, clearly stipulates that any adjustment on account of differences affecting materially the profitability is to be made to the net profit margin of the comparables as referred to in clause (e)(ii). By taking the net profit margin of the assessee without considering the depreciation in order to make adjustment on account of difference in capacity utilization, what the assessee has sought to do is to make adjustment to the net profit margin of the assessee as referred to in clause (e)(i) of sub Rule (1) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty to 10%, i.e. at par with the tested party. Similarly, if the adjustment is made in the profit margin of a comparable having 60% capacity utilization by allocating more fixed overheads at 6.67% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the said comparable would be reduced by Rs. 0.40 crores thereby giving a net profit of Rs. 0.60 crores which would bring the profitability to 10% i.e. at part with the tested party. 25. Having held that the adjustment on account of difference in capacity utilization is required to be made and having explained with illustration that the same can appropriately be made by absorbing or allocating fixed overheads such as depreciation on sales of the comparable at the same rate as that of the tested party, we are of the view that such absorption or allocations of fixed overheads on operating cost instead of sales would be more appropriate as the same will eliminate the effect of difference in profit margin or difference in level of stock of finished goods, if any, of the tested party and comparables. 26. In so far the present case is concerned, it is observed that depreciation claime ..... X X X X Extracts X X X X X X X X Extracts X X X X
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