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2016 (6) TMI 633 - ITAT BANGALORE

2016 (6) TMI 633 - ITAT BANGALORE - TMI - Transfer pricing adjustment - Selection of Premier Ltd. as a comparable - Held that:- It is clear that the assessee itself has considered the comparability at the entity level rather than only at the engineering segment level as is being contended now. However, in the interest of equity and justice, it is necessary to examine this issue as to whether only the engineering segment of Premier Ltd., needs to be taken for determining its comparability. It was .....

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essing Officer/TPO before deciding the matter in accordance with law.

T.P. Adjustment made at Enterprise Level - Held that:- TPO ought to have either accepted the explanations furnished by the assessee or adopted the recast segmental details proposed by him after rejecting the explanations of the assessee. Instead of adopting either of the two, the TPO proceeded to consider the financial results at the entity level, without adducing proper reasons. In this factual matrix, we are unab .....

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gin of the comparable companies at 18.76% whereas the average margin of the comparable selected by the TPO works out to 6.40% - Held that:- We find from a perusal of the TPO’s order under Section 92CA of the Act, at para 10.4 / page 10 thereof, the TPO has selected 7 companies as comparables to the assessee, giving the individual margins of each company and has computed the margin of the comparable companies at 13.57%. From the details extracted by the TPO in the table of seven comparable compan .....

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tunity of being heard.

Adjustment for under utilization of capacity - as per assessee that its capacity utilization was only to the extent of 14.84% of its installed capacity, mainly due to the economic slow down - Held that:- The capacity worked out by the assessee, is the total installed capacity. However, the optimum capacity that can be utilized is the right figure that needs to be adopted for comparability. It is well known that manufacturing industries cannot always operate to f .....

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e capacity utilization of the assessee to evaluate the under-utilisation of capacity, in the case on hand.

The underlying principle is that if the manufacturing unit operates at less than optimum capacity, then it will affect the recovery of fixed cost, thereby affecting profitability. However, it is seen that the adjustment has been worked out by the assessee by considering all the non-operating costs also and there is no relation to the capacity utilization of the comparable compani .....

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- Prior to the amendment made by Finance Act (No.2) Act, 2009 and Finance Act, 2012, the proviso to Section 92C(2) of the Act provided that the ALP would be taken to be the Arithmetical Mean (‘AM’) or at the option of the assessee, a price which may vary from the AM by on account not exceeding 5% of such AM. Thus, the ALP was + / - 5% from such AM. The new section 92C(2A) mandates that if the arithmetical mean price falls beyond + / - 5% from the price charged in the international transactions, .....

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Act and are not applicable to the facts of the assessee's case. In view of the amendment brought about therein by Finance Act, 2012, this ground raised by the assessee is not maintainable and is accordingly dismissed.

Set off of carry forward losses - Held that:- As find from a perusal of the orders of assessment, that this issue has not been addressed by the Assessing Officer, we direct the Assessing Officer to examine and verify the assessee's claim for set off of carried forward lo .....

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tatement of receivables/payables which are Balance Sheet items and we do not find any clear finding in this regard in the orders of the authorities below. Therefore, we remand the issue back to the Assessing Officer /TPO to examine / determine whether the entire foreign exchange gain has arisen out of the export business of the assessee and thereafter to that extent treat the same as operating in nature while computing the margins of the assessee and the comparable companies after affording the .....

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ssessment for Assessment Year 2010-11 passed under Section 143(3) rws 144C(13) of the Income Tax Act, 1961 (in short 'the Act') vide order dt.31.12.2014, in pursuance of the directions issued by the Dispute Resolution Panel ( DRP ) under Section 144C(5) of the Act dt.21.11.2014. 2. The facts of the case, briefly, are as under :- 2.1 The assessee company is engaged in the manufacturing and trading of wood working machinery, spare parts and tools and also provides software testing, technic .....

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ALP ) of the international transactions reported by the assessee, after obtaining the approval of the CIT-I, Bangalore. The TPO passed an order under Section 92CA of the Act dt.15.1.2014 proposing a T.P. Adjustment of ₹ 11,62,02,178 to the international transactions entered into by the assessee in the period under consideration. 2.2 After receipt of the TPO s order, the Assessing Officer passed the draft order of assessment under Section 143(3) rws 144C of the Act dt.28.2.2014, wherein the .....

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at ₹ 1,84,17,896 and which included T.P. Adjustment of ₹ 10,67,28,496. 3. Aggrieved by this order of assessment dt.3.12.2014 for Assessment Year 2010-11, both the assessee and Revenue have preferred appeals raising the following grounds :- 3.1 Assessee's grounds of appeal are as under :- 1. The Order of the Learned DCIT in so far as it is prejudicial to the interest of the Appellant is not justified in law and on facts and circumstances of the case. 2. The Directions of the Hono .....

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the same does not satisfy the tests of comparability. 5. Without prejudice to the above, assuming without conceding that M/s. Premier Ltd. is a comparable Company, the Honourable DRP is not justified in failing to appreciate that only the results of engineering segment are to be considered for the purpose of benchmarking with the Appellant. 6. The Honourable DRP, having accepted that comparable net margin under TNMM is to be applied on only international transactions, is not justified in uphold .....

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between the revised figures and the figures in the TP study. 8. The Honourable DRP is not justified in upholding the action of the Learned TPO in computing arm s length price under Section 92CA of the IT Act by taking incorrect average margin of 18.76% [which includes M/s. Premier Ltd., which does not satisfy the tests of comparability] as against the correct average margin of 6.40% of the comparable companies. 9. Without prejudice to the above, assuming without conceding that M/s. Premier Ltd. .....

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no reliable information regarding the under utilization of capacity despite Appellant having furnished the Chartered Engineering Certificate and related information. 11.The Honourable DRP is not justified in perversely stating that the Appellant s data are not reliable without finding specifically any particular item of data as being not reliable or incorrect. 12.The Honourable DRP is not justified in upholding the action of the Learned TPO in denying adjustment in respect of abnormal employee .....

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t justified in upholding the levy of interest under sections 234B & 234D of IT Act when the conditions for levying such interest did not exist in the present case. 3.2 Revenue has raised the following grounds of appeal:- 1. The directions of the Dispute Resolution Panel are opposed to law and facts of the case. 2. On the facts and in the circumstances of the case the Hon'ble DRP erred in holding that foreign exchange loss/gain is operating in nature when, such loss/gain through attributa .....

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it is prayed that the directions of the DRP in so far as it relates to the above grounds may be reversed. 5. The appellant craves leave to add, alter, amend and/or delete any of the grounds mentioned above. 4.1 T.P. Issues 4.1 The assessee is engaged in production and trading of wood working machinery and spare parts. The financial results of the assessee, at an entity level, were reported as under :- Particulars Amount (Rs.) Operating Revenue 25,20,15,283 Operating Cost 32,42,20,711 Operating P .....

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n Amount Rs. Purchase of components 10,45,52,930 Sale of goods 10,70,14,327 Import of finished goods 1,38,99,316 Purchase of capital goods 1,07,13,580 Receipt on account of provision of services. 2,27,95,313 Interest paid on loan (6 month Euribor + 50 basis points - total interest rate is 1.46%) 35,79,962 Reimbursement of expenses paid 2,31,51,238 Total : 28,60,06,666 4.2 In the T.P. Documentation submitted to the TPO, the assessee had mentioned that it is into both manufacturing and trading act .....

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ng segment. Similarly, the assessee selected asset of 8 comparables with the average arithmetic mean margin of 14.78% for the trading segment. 4.3 The assessee had attributed the losses in the manufacturing segment mainly to start up losses and under utilization of capacity and had sought adjustments for such under utilization of capacity to conclude that the international transactions of its manufacturing segment were at arm s length. It was the contention of the assessee that the capacity util .....

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f the claim for alleged under utilization of capacity has been filed; (ii) The revised segmental financials in respect of the manufacturing and trading segments submitted in TP proceedings before the TPO were different from the details furnished in the TP Report and the assessee was not able to explain the anomalies which were pointed out in the show cause notice; (iii) Though the assessee submitted that separate set of books were maintained for trading and manufacturing activities, there is no .....

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ilization of capacity, the TPO proceeded to complete the proceedings adopting TNMM as the MAM, as was taken by the assessee. The TPO observed that the assessee had adopted multiple years data for computation of the average margins of the comparable companies. The TPO considered only those comparable companies whose financial data for the current year, i.e. F.Y.2009-10 was available in the TP document and he therefore accepted only 7 companies as comparable out of the 16 companies selected by the .....

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nt as under :- Operating Cost Rs.32,42,20,711 Arm s Length Margin 13.57% of Operating Cost Arm s Length Price @ 113.57% of operating cost Rs.36,82,17,461. Price Received Rs.25,20,15,283 Shortfall being adjustment u/s.92CA Rs.11,62,02,178 The aforesaid adjustment of ₹ 11,62,02,178 as proposed by the TPO was incorporated by the Assessing Officer in the draft assessment order dt.8.2.2014. The assessee's objections filed before the DRP were disposed off by issue of directions under Section .....

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preferred this appeal before the Tribunal raising 15 grounds (supra). The grounds raised by the assessee, briefly, pertain to the following issues :- 5.1.1 Grounds S.No.1 to 3 - are general in nature and not being specifically urged before us, are rendered infructuous and are accordingly dismissed. 5.1.2 Ground Nos.4 to 5 and 8 and 9 - pertain to the selection of Premier Ltd., as a comparable by the TPO. 5.1.3 Ground Nos.6 & 7 - pertain to the applying of adjustment at the entity level inste .....

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ecifically urged before us, are rendered infructuous and are accordingly dismissed. 7. Ground Nos.4, 5, 8 & 9 - Selection of Premier Ltd. as a comparable. 7.1 In these Grounds, the assessee has objected to the inclusion of this company in the final set of comparables chosen by the TPO. According to the assessee, this company does not satisfy the tests of comparability and contends that merely because this company was selected as a comparable company in its T.P.Study, there is no estoppel aga .....

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this company as a comparable to the assessee in the case on hand. 7.3.1 We have heard the rival contentions and perused and carefully considered the material on record. Admittedly, this company was selected as a comparable company by the assessee itself in its T.P. Study as it satisfies all the criteria for comparability adopted by the assessee. In fact, the TPO has accepted all the comparables adopted by the assessee which had the current financial year data. 7.3.2 Before us, the assessee has .....

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.P. Study. However, the onus is upon the assessee to establish with material evidence as to how and why this company is not comparable now, when it was chosen as a comparable in its own T.P. Study. In our view, the assessee has not discharged its onus of producing any material evidence to show that this company, M/s. Premier Ltd. is not comparable to the assessee and in the absence of any evidence to establish its claim, the contentions of the assessee cannot be accepted. 7.3.3 As regards the as .....

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e, it is necessary to examine this issue as to whether only the engineering segment of Premier Ltd., needs to be taken for determining its comparability. It was contended that before us that this issue was raised before the DRP, but the DRP had not adjudicated on the same. Therefore, we deem it appropriate to remand this issue to the file of the Assessing Officer/TPO for fresh consideration as to whether only the engineering segment of this company should be considered for comparability. Needles .....

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of the manufacturing segment at the enterprise level despite having the segmental details/results. It is the contention of the assessee that since separate books of accounts are maintained in respect of the two segments, the TPO ought to have considered the details related to the manufacturing segment only, for bench marking the transactions related to the manufacturing segment. 8.2.1 We have heard both parties and perused and carefully considered the material on record. It is not in dispute th .....

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the margin of (-) 43.5% for the manufacturing segment and 48.5% for the trading segment. 8.2.2 After seeking the explanation of the assessee for the anomalies in the details furnished and proposing to recast the segmental details, the TPO ought to have either accepted the explanations furnished by the assessee or adopted the recast segmental details proposed by him after rejecting the explanations of the assessee. Instead of adopting either of the two, the TPO proceeded to consider the financia .....

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tions. Consequently, the Grounds raised at S.Nos.6 & 7 are allowed. 9. Ground No.8 : Incorrect Margin. 9.1 In this Ground, the assessee contends that the TPO has wrongly computed the average margin of the comparable companies at 18.76% whereas the average margin of the comparable selected by the TPO works out to 6.40%. 9.2 We have examined this issue. We find from a perusal of the TPO s order under Section 92CA of the Act, at para 10.4 / page 10 thereof, the TPO has selected 7 companies as c .....

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rging from the TPO s Table at page 10 of his order. In this factual matrix, we direct the TPO to examine the margins of comparable companies and compute the margins correctly after affording the assessee adequate opportunity of being heard. Consequently, this Ground is treated as allowed for statistical purposes. 10. Ground Nos. 10 to 12 - Adjustment for under utilization of capacity. 10.1 In these Grounds, the assessee has put forth its claim for adjustment on account of under utilization of ca .....

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under-utilisation of capacity. 10.2 Before the DRP, the assessee submitted a certificate from a Chartered Engineer giving details of the capacity to produce various types of machines and their utilization thereof. However, the DRP upheld the decision of the TPO and rejected the assessee's claim of under-utilisation of capacity. 10.3 Aggrieved by the decision of the authorities below in turning down its claim for adjustment on account under-utilisation of capacity, the assessee submitted det .....

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iance on the following decisions :- (i) DCIT V Petro Araldite P. Ltd. (2012) 148 ITD 182 (Mum-ITAT); (ii) Genisys Integrating Systems (India) Pvt. Ltd. (2012) 15 ITR (Trib.) 475 (Bangalore). 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-utilisation of capacity is allowable in the case on hand and if so, the manner .....

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ustments can be made to eliminate the material effects of such differences. 10.4.3 The concept of adjustment for capacity under-utilisation of manpower was recognized by the co-ordinate bench of this Tribunal in the case of Genisys Integrating Systems (India) Pvt. Ltd. (supra) wherein at para 15.2 thereof it was observed that - 15.2 We agree with this contention of the counsel for the assessee. All the comparables have to be compared on similar standards and the assessee cannot be put in a disad .....

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ained by the ITAT, Mumbai Bench in the case of Petro Araldite P. Ltd. (supra) as under :- 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 nulli .....

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n, it is necessary first to see the procedure laid down for carrying out the exercise of comparability analysis and making suitable adjustments. This procedure as laid down in section 92-C of the Act provides that the ALP in relation to an international transaction shall be determined by any of the methods specified therein, being the most appropriate method and the manner in which the said ALP has to be determined is given in section 92-C(2) of the Act read with Rule 10B of the Income Tax Rules .....

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ployed 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 and the comparable unco .....

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ing in view the aforesaid provisions of the relevant Rule, we can now endeavor to consider how and to what extent the difference 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 type .....

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r 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 profit margin. The following simple example would further explain this position: Installed capacity in monetary terms ₹ 10 crores ₹ 10 crores ₹ 10 crores C .....

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d lower profitability at lower realization. This happens mainly because of higher allocation or absorption of fixed overheads at lower capacity utilization which comes down as the level of capacity utilization goes up. For instance, as given in the above example, the rate of allocation or absorption of fixed overheads to sales is 40% at 50% capacity utilization while it becomes 33.33% at 60% capacity utilization and 25% at 80% capacity utilization giving more profit margin of 16.67% at 60% capac .....

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(1) of Rule 10-B of the Income Tax Rules, 1962. 22. Having held that the adjustment is required to be made to the net margin of the comparables on account of difference in capacity utilisation, the next issue that arises is regarding the adoption of proper method by which the same can appropriately be made. In the present case, the assessee made this adjustment by not considering depreciation for computing its own operating profit as well as the operating profit of comparable. It was done by ta .....

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epreciation 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 acco .....

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permissible in accordance with clause (e)(iii) of sub Rule (1) of Rule 10B. 23. The question that now arises is what is the proper method of making adjustment for difference in capacity utilization within the frame work given in Rule 10B. As already discussed by us, the difference in capacity utilization affects the profitability mainly because of the difference in rates at which the fixed overheads are absorbed or allocated depending on the level of capacity utilization. The example given by u .....

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0% capacity utilization as that of the tested party and at capacity utilization of 60% and 80% as that of the comparables and adjust the rate of allocation of fixed overheads of the comparables in order to bring the same at par (i.e. 40% of sales) with the tested party, the resultant position will be as under:- Net profit ₹ 1 crore ₹ 2.00 crores Less additional allocation of depreciation by taking the rate of fixed overheads at 40% of sales: ₹ 0.40 crores ₹ 1.20 crores Ne .....

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case of the tested party. If the adjustment is made in the profit margin of the said comparables by allocating more fixed overheads at 15% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the comparable would be reduced by ₹ 1.20 crores thereby giving a net profit of ₹ 0.80 crores which would bring the profitability to 10%, i.e. at par with the tested party. Similarly, if the adjustment is made in the profit margin of a c .....

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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 c .....

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he ld. CIT(A) excluding the depreciation entirely for the purpose of computing operating profit and direct the A.O. to make the adjustment as given above for difference in capacity utilization after verifying the stand of the assessee that the capacity utilization of comparable company finally selected viz. Rasin Plastic Ltd. was more by 10-15%than that of the assessee during the year under consideration. Ground No. 1 of the Revenue s appeal is thus partly allowedwhereas ground No. 2 & 3 are .....

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stment for capacity underutilisation can be granted. Having so held in principle, we now examine the facts of the case on hand in the light of the above principle. 10.4.6 A perusal of the orders of the TPO and DRP show that the authorities below have not held that capacity utilization adjustment should not be granted to the assessee. Rather, it appears that they have rejected the assessee's claim of adjustment for under-utilisation of capacity on the grounds that the assessee has not furnish .....

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d in the manufacturing facility. These calculations, it appears, are based on certain assumptions like, for example; i) The capacity to manufacture different machines has been worked out by considering the minimum time required for the same. The basis of this assumption has not been spelt out. ii) It has also not been spelt out as to how the minimum time required for the various machines has been worked out. iii) The capacity has been worked out by assuming 3 shifts per day i.e. it is assumed th .....

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ll known that manufacturing industries cannot always operate to full installed capacity. It will be a wrong assumption to make that the comparable companies are all operating to their full installed capacity. The capacity to which the manufacturing units can be reasonably expected to operate is the optimum capacity and this can / will vary from industry to industry. It is essential to understand the capacity at which the comparable companies operated during that relevant period. The capacity at .....

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ench has classified the costs into fixed and variable costs and has allowed the allocating of fixed overhead costs for the purposes of computing of the capacity utilization adjustment. The underlying principle is that if the manufacturing unit operates at less than optimum capacity, then it will affect the recovery of fixed cost, thereby affecting profitability. However, it is seen that the adjustment has been worked out by the assessee by considering all the non-operating costs also and there i .....

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ted (supra). Needless to add, the assessee shall be afforded adequate opportunity of being heard and to make submissions / file details in this regard which shall be duly considered by the TPO before coming to a decision in the matter. Consequently, the Grounds at S. Nos. 10 to 12 on this issue are treated as allowed for statistical purposes. 11.1 In Ground No.13, the assessee contends that as per the mandate of the 2nd proviso to Section 92C(2) of the Act, the assessee is entitled to the benefi .....

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nded w.e.f. 1.4.2002 by the introduction of a clarificatory amendment in which Section 92CA was inserted as per Finance Act, 2012. 11.3 The new section 92C(2A) mandates that if the arithmetical mean price falls beyond + / - 5% from the price charged in the international transactions, then the assessee does not have any option referred to in section 92C(2). Thus, as per the above amendment, it is clear that the + / - 5% variation is allowed only to justify the price charged in the international t .....

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dismissed. 12. Ground No.14 : Set off of carry forward losses. 12.1 In this Ground, the assessee contends that it has been wrongly denied the benefit of set off of carried forward losses to the extent of ₹ 1,16,71,624 by the authorities below. Since we find, from a perusal of the orders of assessment, that this issue has not been addressed by the Assessing Officer, we direct the Assessing Officer to examine and verify the assessee's claim for set off of carried forward losses in accord .....

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ficer in charging the said interest. The Assessing Officer is, however, directed to recompute the interest chargeable u/s. 234B and 234D of the Act, if any, while giving effect to this order. 14. In the result, the assessee's appeal for Assessment Year 2010-11 is partly allowed for statistical purposes. Revenue s appeal for Assessment Year 2010-11 in IT(TP)A No.493/Bang/2015 15. The Grounds at S.Nos.1, 4 & 5 are general in nature and therefore no adjudication is called for thereon. 16. G .....

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from the operating activity of the assessee. The learned Departmental Representative was heard in support of the grounds raised. 16.2 Per contra, the learned Authorised Representative supported the impugned order of the DRP in holding foreign exchange gain/loss to be part of the operating revenue for the purpose of computing the assessee's margin for comparison with the margin of the comparable companies. The learned Authorised Representative contended that revenue s appeal on this issue is .....

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supra) and Sap Labs India (P) Ltd. (2011) 44 SOT 156 (Bang). 16.3 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial decisions cited and placed reliance upon. We observe that it has not been disputed that the foreign exchange gain/loss has arisen as a consequence of the realization of the consideration in the course of business operation for rendering software development of the assessee and therefore there is no reason for its .....

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as been upheld by a co-ordinate bench of this Tribunal in the case of NXP Semi Conductors India Pvt. Ltd. in IT (TP) A No.1662/Bang/2014 dt.12.8.2015 wherein at para 4.3 thereof it has been held as under :- 4.3 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial decisions cited and placed reliance upon. We observe that it has not been disputed that the foreign exchange gain/loss has arisen as a consequence of the realization of .....

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fully considered the material on record; including the judicial decisions cited and placed reliance upon. We observe that it has not been disputed that the foreign exchange gain has arisen as a consequence of the realization of the consideration for rendering ITES services and therefore there is no reason for its exclusion from the operating revenues for the purpose of calculating the operating margin of the assessee. We find that this proposition has been upheld by a co-ordinate bench of this T .....

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the operating revenue for the purpose of calculation of operating margin. In our view, the analogy drawn by the DRP regarding exclusion of interest expenses while computing operating margins is not proper. In our view, foreign exchange gain on realization of consideration for rendering software development services should be regarding as part of the operating revenue. Following the decision of the ITAT, Bangalore Bench in the case of SAP Labs (supra), we hold that the operating revenue for the .....

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