TMI Blog2016 (6) TMI 633X X X X Extracts X X X X X X X X Extracts X X X X ..... nt 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 unable to agree with the stand of the TPO. It is settled principle, upheld in several decisions, that the T.P. Adjustment has to be done only in respect of the assessee's international transactions with AEs and not on the non-AE component of the transactions. We, therefore, direct the TPO to make the adjustments only for the international transactions and not on the non-AE component of such transactions Incorrect Margin - 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% - 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 ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter, we deem it appropriate, in the interest of justice and equity, to remand the issue back to the file of the TPO to work out the capacity utilization adjustment. Entitlement to the benefit of + / - 5% while computing the ALP of international transactions - Held that:- 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, 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 transactions and not for adjustment purposes. The aforesaid amendment has settled the issue and accordingly the 5% benefit is not allowable in the assessee's case. The various judicial decisions cited pertain to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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, technical design and marketing services to its parent company, Biesse Spa, Italy. The assessee filed its return of income for Assessment Year 2010-11 on 14.10.2010 declaring loss of ₹ 8,83,10,550. The case was processed under Section 143(1) of the Income Tax Act, 1961 (in short 'the Act') and the case was subsequently taken up for scrutiny. The Assessing Officer made a reference under Section 92CA of the Act to the Transfer Pricing Officer ( TPO ) for determining the Arm s Length Price ( 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Learned TPO in rejecting the segment data despite the Appellant having fully explained the differences observed by the Learned TPO 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. is a comparable Company, 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% as against the correct average margin of 8.98% of the comparable companies. 10.The Honourable DRP is not justified in upholding the action of the Learned TPO in denying adjustment in respect of under utilization of capacity while determining the ALP by perversely stating that there is no reliable information regarding the under utilization ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Particulars Amount (Rs.) Operating Revenue 25,20,15,283 Operating Cost 32,42,20,711 Operating Profit / Cost (-) 7,22,05,428 OP/OC % (-) 22.27% OP / Sales % (-) 28.65% The Segmental Results as reported in the assessee's T.P. Documentation is as under :- Particulars Manufacturing (Rs.) Trading (Rs.) Operating Revenue 17,08,11,421 9,31,37,089 Operating Cost 28,31,58,271 4,74,68,913 Operating Profit / Cost (-) 11,23,46,850 4,56,68,176 OP/OC % 48.64% -- OP / Sales % -- 49.03% During the year under consideration, the assessee has reported the following international transactions :- Transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 separate reporting for trading and manufacturing segments of the tax payer. (iv) Mere filing of capacity working of plant is not sufficient for granting adjustment on account of under utilization of capacity of plant, in the absence of supporting evidence. After having made the above observations, the TPO considered the financials of the assessee at the entity level for comparability analysis under TNMM in the manufacturing segment. 4.5 After having rejected the assessee's claim for under utilization 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Year 2010-11 dt.31.12.2014, the assessee has 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 instead of on the international transactions; 5.1.4 Ground Nos. 10 to 12 pertain to adjustment for capacity under utilization. 5.1.5 Ground No.13 pertains to the benefit of + / - 5% deduction; 5.1.6 Ground No.14 pertains to the set off of carry forward losses; 5.1.7 Ground No.15 pertains to the charging of interest under Section 234B and 234D of the Act. We now proceed to examine the issues raised in the assessee's appeal. 6. The Grounds at S.Nos. 1 to 3 being general in nature and not specifically urged before us, are rendered infructuous and are accordingly dismissed. 7. Ground Nos.4, 5, 8 9 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee's contention that only the engineering segment of this company, Premier Ltd., has to be considered for the comparability analysis it is seen that the margin adopted by the TPO for this company is the same as that shown in the assessee's T.P. Study. Therefore, in our view, 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 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. Needless to add that the assessee shall be afforded adequate opportunity of being heard and submit details required in the matter, which shall be considered by the Assessing Officer/TPO before deciding th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rect 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 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 companies at page 10 of the TPO s order, prima facie, it appears that the average margin is certainly computed wrongly at 13.57% and rather should be 9.618%. The figures of average margin given by the assessee at 18.76% and 6.40% also, prima facie, appear to be at variance with those emerging 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 allo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble to an international 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. 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 disadvantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure. The Assessing Officer shall consider this fact also while determining the ALP and make the TP adjustments. With these directions, the appeal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 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 established is then taken into account to arrive at an arm s length price in relation to the international transaction; 20. Keeping 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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% capacity utilization and 25% at 80% capacity utilization as against profit margin of 10% at 50% capacity utilization. The difference in capacity utilization thus materially affects the profit margin and if there is a difference in the level of capacity utilization of the assessee and the level of capacity utilization of the comparable companies, adjustment is required to be made to the profit margin of the comparables on account of difference in capacity utilization as per clause (e)(iii) of sub-rule (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 taking EBDIT as PLI instead ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit margin. For example, if we take the profitability working at 50% 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 Net profit after adjustment ₹ 0.60 crores ₹ 0.80 crores Profit margin after adjustment 10% 10% 24. The adjustment thus can be made to the profit margin of the comparables by allocating fixed overheads at the same rate at which fixed overheads are allocated in the case of the tested party. For example, in the case of a comparable having 80% capacity utilization, the rate of allocation of depr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ected 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 dismissed. 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 underutilisation can be granted. Having held that this adjustment can be granted, the Tribunal has also held that such adjustment can be made by allocating fixed overheads at the same rate as that of the tested party. Following the decision of the ITAT, Mumbai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment 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 fu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s not in keeping with the judicial decision cited above i.e. Petro Araldite P. Ltd. (supra). In this decision, the ITAT, Mumbai Bench 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 is no relation to the capacity utilization of the comparable companies. In view of the above, the TPO and DRP cannot be faulted for holding that the assessee has not established the quantum of capacity utilization adjustment with evidences and supporting details. In this view of the matter, we deem it appropriate, in the interest of justice and equity, to remand the issue back to the file of the TPO to work out the capacity utilization adjustment on the lines laid out in the aforesaid decision cited (supra). Needless to add, the assessee shall be afforded adequate o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aim for set off of carried forward losses in accordance with law, after affording the assessee adequate opportunity of being heard in the matter. 13. In Ground No.15, the assessee denies itself as being liable to be charged interest under Section 234B and 234D of the Act. The charging of interest is consequential and mandatory and the Assessing Officer has no discretion in the matter. This proposition has been upheld by the Hon'ble Apex Court in the case of Anjum H Ghaswala (252 ITR 1) and we, therefore, uphold the action of the Assessing Officer 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. Ground Nos.2 3 : Treatment of Foreign Exchange Gain as operating in nature . 16.1 In the Ground Nos.2 and 3 , Revenue contend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -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 the consideration for rendering software development 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 Tribunal in the case of Amba Research India Pvt. Ltd. in IT(TP)A No.1376/Bang/2014 dt.17.4.2015 wherein at para 5.7 thereof it has been held as under :- 5.7 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 has arisen as a consequenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onductors India Pvt. Ltd. (supra), we hold that operating revenue should be computed by including the foreign exchange gain which is clearly arising out of the export business; is related to the profit and loss account and is in the revenue field. However in the case on hand, the assessee has stated that the foreign exchange gain is arising out of restatement 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 assessee adequate opportunity of being heard and submit details submissions in the matter. 17. In the result, Revenue s appeal for Assessment Year 2010-11 is treated as partly allowed for statistical purposes. 18. To sum up, Revenue s appeal for Assessment Year 2010-11 and Assessee's cross appeal are both partly allowed for statistical ..... X X X X Extracts X X X X X X X X Extracts X X X X
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