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TMI Blog2018 (5) TMI 1078X X X X Extracts X X X X X X X X Extracts X X X X ..... e extent of depreciation only ignoring the working done by the TPO. 4. Whether in the facts and circumstances of the case, the Ld. CIT (A) erred in allowing the exceptional replacement cost of Rs. 10.72 crores whereas the MOU between assessee and Honda Seil Cars limited provides for Rs. 6.11 crores. 5. That the order of the Ld CIT (A) is erroneous and is not tenable on facts and in law." 2. The assessee is a company engaged in the business of manufacture and sale of automobile components i . shock absorbers. It filed its return of income at Rs. 10,23,61,920/- and the assessment was made on 31/12/2008 by The Additional Commissioner Of Income Tax, Range 5, Delhi (Ld. AO) u/s 143 (3) read with section 92CA (3) of The Income Tax Act 1961 ( The Act) . The Ld. AO added an adjustment to the total income on account of the difference in the arm‟s length price ( ALP) of the international transaction of Rs. 22,66,12,074/-. 3. Brief facts of TP adjustment shows that assessee has entered into an international transaction with its associated enterprise for purchase of components and parts, purchase of capital goods, export of goods, payment of technical services fees, payment for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d at the sale price after taking into account the prevailing cost of component and technology. The Ld. TPO also noted that the assessee has failed to furnish any evidence for sudden unavailability and steep rise in cost of component and technology which could prove that the price setting mechanism of the assessee with regard to this of absorber went wrong. It was further noted by him that the import was made from associate companies and the assessee failed to prove if these imports were at arm‟s length price or not. The Ld. Transfer Pricing Officer also noted that assessee failed to substantiate its claim in absence of making CUP for identical products by the associated enterprise of the assessee to other parties. The assessee also sought an adjustment because of the downward revaluation of inventory with respect to Unicorn product. The Ld. Transfer pricing officer rejected the same. However the Ld. assessing officer Granted an adjustment of Rs. 6.11 crores on account of abnormal cost incurred by the assessee in relation to the supply of goods to Honda Seil Car Limited from the total cost incurred by the assessee of Rs. 517 crores. Based on the above adjustment the profit lev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rating income of the assessee where the total cost was considered at Rs. 517 crores which was further reduced by the Ld. CIT (A) by abnormal cost of Rs. 24.01 crores resulting into adjusted total cost of Rs. 493 crores. The operating revenue of the assessee was Rs. 523.28 crores and the operating profit of the assessee was Rs. 30.24 crores which resulted into the profit level indicator of operating profit/operating income of 5.78 %. He also allowed the capacity utilization adjustment to the extent of the depreciation cost and held that as the profit margin of comparable company is 5.81% as against 5.78% of the appellant company the whole transfer pricing adjustment does not survive. 6. Aggrieved, by the order of the Ld. CIT (A) the revenue is in appeal before us. The main grievance of the revenue is the granting of the deduction of abnormal cost as product recall expenses, inventory valuation, and higher cost of purchases etc. 7. Assessee moved an application under Rule 27 of The Income Tax Appellate Tribunal Rules, 1963 stating that Renowned Auto Products Manufacturing Ltd ought to have been considered as a comparable for undertaking benchmarking analysis applying Transactional ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... negative net worth in one year does not make it a non-comparable company. It has been shown before us that comparable has negative net worth only in FY 2004-05 and in subsequently it turned out to be in positive. In case of Negative net worth companies if selected by the assessee, it is the duty of the assessee to show that functional similarity between the comparable exists and the negative net worth of the company has no impact on the profitability of that comparable company. If the TPO rejects the comparable selected by the assessee, which is otherwise functionally comparable but has negative net worth, it is the duty of the TPO to show that negative net worth of the company has impacted its profitability in such a manner that its financial operations are not comparable with the assessee or its pricing has been adversely impacted due to it. Comparable having net worth can be rejected only when the parties prove that it has neither impacted Functions, Assets and Risk of the comparable and nor has impacted the pricing thereof. Neither party has shown before us that what affects the negative net worth of the comparable has made on its profitability for comparability analysis. Befor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ars there is a growth @165%. With respect to the decrease in the value of inventory, he stated that above provision is as per AS-2 and the value of closing stock decreased by Rs. 4.77 crores because of special variety of shock absorber to be used in Unicorn Model of Honda Motorcycles. In view of this it was submitted that aggregate of the adjustment of aforesaid cost is required to be added to the operating profit of the assessee. He therefore, submitted that if then the margin of the assessee is compared with the Gabriel India, then operating profit of the assessee would be higher than operating profit of Gabriel India Ltd. 12. We have carefully considered the rival contentions and also perused the orders of the lower authorities. The assessee has asked for removal of certain cost from the operating cost of the assessee as according to it those costs have not been incurred in the normal course of the business but are extra ordinary items. In fact before deciding on removal of any cost component from the operating cost of the assessee for working out PLI, it needs to be verified whether the risk associated with the product in the case of the assessee as well as in the case of comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be reimbursed by the appellant. The aforesaid finding of the TPO is incorrect. Out of the total expenditure of Rs. 10,72,32,133, incurred on replacement of defective parts supplied to HSCI, the TPO has only considered the portion of the expenses which was incurred at the end of the customer, viz., HSCI, and reimbursed by the appellant. The TPO did not take into account remaining amount of expenditure of Rs. 4,60,69,887 incurred on recall of defective products at the end of the appellant. The entire expenditure incurred on recall of defective products supplied to HSCI of Rs. 10,72,32,133 is clearly reflected in the audited financials of the appellant as exceptional item. The assessing officer / TPO is accordingly directed to consider the entire expenditure of Rs. 10,72,32,133 as abnormal expenditure incurred on recall of defective products, viz., Struts (including bottom tube) supplied by the appellant to HSCI as abnormal item of cost which is not present in the financial of the comparable company, viz., Gabriel India Ltd. The remaining expenditure of Rs. 2.54 crores incurred on account of increased cost on account of import of bottom tube from Japan ensure continuous supply ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k absorber for Unicorn at market price as against higher cost of production. 12.7 The appellant has submitted that it has undervalued the closing stock of monoshock absorber manufactured for Unicorn two wheelers by Rs. 4.77 crores as cost of production of such product was higher than the realizable value/market price. The aforesaid is purely an accounting adjustment which results in a mismatch of cost charged to profit and loss account and valuation of stock on the credit side of the profit and loss account. Such adjustment distorting the actual profit is required to be ignored for determining the operating profit margin for undertaking benchmarking analysis applying TNMM. I agree with the contention of the appellant that such distortion is required to be eliminated from the profit and loss account to recompute the correct operating profit margin from transactions entered into by the appellant. From the detail of valuation of closing stock furnished by the appellant, it was found that net realizable value (NRV) in respect of some items is in range of 90% whereas it is about 30% in respect of other items. Therefore, all the entries in valuation of closing stock do not represent e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in the charge of depreciation, which is the major item of fixed cost in the profit and loss account in as much as other costs or expenses are incurred considering the operational capacity and are commensurate with the capacity actually utilized. (b) Capacity utilization at best may provide the benefit to the appellant on account of lower incidence of depreciation as higher production is achieved using the same plant and machinery and other fixed assets. Even considering the adjustment made on account of capacity utilization by adjusting the depreciation to that extent, the normalized profit and loss account of Gabrial India would reflect as under: * Depreciation as per P & L A/c of Gabriel India = Rs. 15.23 crores * Adjusted depreciation = Rs. 15.23 x 66.12 / 95.12 = Rs. 10.59 crores Finance- Profit and Loss-Gabriel India Ltd (Rs in Cr.) INCOME: * Sales Turnover ^ 477.86 * Excise Duty 64.61 * Net Sales '413.25 * Stock Adjustments 5.09 Total Income 418.34 EXPENDITURE * Raw Materials 254.7 * Power & Fuel Cost 10.9 * Employee Cost 31.14 * Other Manufacturing Expenses 44.73 * Selling and Administration Expenses 38.48 * Mi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ference in capacity utilization of the appellant and of the Gabriel, in my view, is inappropriate and is not consistent with the accepted principles of commercial accountancy. Capacity utilization at best may provide the benefit to the appellant on account of lower incidence of depreciation as higher production is achieved using the same plant and machinery and other fixed assets. After making capacity utilization adjustment to the extent of depreciation cost, the profit margin (OP/OI %) of Gabriel India Ltd. would work out to 5.81% as against 5.78% of the appellant. Adjusted operating profit margin of the appellant being within prescribed range of operating profit margin of Gabriel, the international transactions entered into by the appellant is considered as having been undertaken at arm's length price and adjustment made by the TPO of Rs. 22,66,12,074 does not survive. The AO is therefore directed to delete the addition made under transfer pricing adjustement." 13. The assessee has submitted the copies of the orders of the coordinate bench in its own case for AY 2006-07 and 2007-08 wherein in para No. 6 of the order for AY 2006-07 identical reference is for capacity utiliz ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 10.72 crores at page No. 12 of the order of the ld CIT(A) which remains undisputed. Therefore, to this extent no infirmity can be found in the order of the ld CIT (A) in granting the above reduction. In the result Ground no 4 of the appeal of revenue is dismissed. 15. Further assessee has also stated that it has undertaken a contract for supply of new type of shock absorber in „Unicorn„ motor cycle manufactured by HMSI. For which assessee has incurred higher cost of material procurement then what was the price contacted for supply of goods. The ld. AO/ TPO did not accept the claim of the assessee. The ld CIT (A) held it to be extra ordinary expenses item. According to us it is merely a transaction of purchases of import of goods at higher price and its resale to the principal at lower prices. The product are also imported from the Associated concerns. The above loss has been incurred by the assessee as a normal businessperson unless the assessee demonstrates some extra ordinary factors attached to it other than normal business risk elements. Merely because the assessee is supplying a product for a new vehicle, when assessee is in the same line of business for a long ..... X X X X Extracts X X X X X X X X Extracts X X X X
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