TMI Blog2018 (5) TMI 1078X X X X Extracts X X X X X X X X Extracts X X X X ..... hicle, when assessee is in the same line of business for a long time, coupled with the fact that products have been imported from the sister concern for onward supply to the principle and later on of prices stabilized, does not make assessee to say that these cost are extra ordinary cost . It is merely a transaction of purchase and sales of goods which has resulted in to lesser profit to the assesee in its business. Assessee has also stated that it is increased cost of production only. Cost of production is the normal activity. No such disclosure is also made in the annual accounts to this effect also. This is a result of normal business risk of the assessee and hence same cannot be reduced from the total cost. Hence, the reduction granted by the ld CIT (A) of ₹ 10.73 crores is not proper. The action of ld CIT (A) is reversed and order of TPO is restored to that extent. In the result Ground no 1 of the appeal of the revenue is allowed Adjustments of the value of the inventory - Held that:- Differential prices were also calculated by applying the rates of the prouct and not identifying each of the components, which is mandatory at the time of valuation of goods. Assessee be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ck absorbers. It filed its return of income at ₹ 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 ₹ 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 royalty and payment for letter of credit. Assessee benchmarked these transactions adopting the Transactional Net Margin Method (TNMM) as the Most Appropriate Method. It adopted Profit Level Indicator of OP/sales selecting 49 comparables whose PLI was 4.22% based on the multiple year data and compared it with the PLI of the assessee at 4.18% and thus submitted that the international transactions entered into by the assessee are at arm‟s length price. The Ld. assessing officer perused the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 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 ₹ 517 crores. Based on the above adjustment the profit level indicator of OP/TC was calculated at 2.42 % and it were compared with the financial of the comparables where the Gabriel India Ltd (sole comparable retained) was computed at 4.70 %. The Ld. assessing officer further granted adjustment on account of capacity utilization of the comparable on the basis of the capacity utilization of the tested party. The Ld. Transfer pricing officer noted the capacity utilization of the assessee at 95.12% whereas the capacit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /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 Net Margin Method. Ld. Transfer Pricing Officer while applying the transactional net margin method rejected it though it is also a shock absorber manufacturer, selected by the assessee as a comparable company, for the reason that the company has negative net worth during the year under consideration. Ld. Authorised Representative submitted that the Ld. CIT (Appeals) did not adjudicate upon the appropr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et 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. Before the impact of negative net worth analyzed or questioned ld TPO has rejected the comparable. The identical comparable was accepted in the earlier assessment years in the case of the company and in one of the earlier years the whole issue has been set aside to the file of the ld DRP where one of the issue is of the selection of this comparable. Therefore in the back ground of past history in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 comparable is similar or not. The method of comparability adopted in TNMM which is tolerant enough to take care of expenses incurred by assessee as well as comparable with respect to normal business functions and risks. Therefore, if any expenditure claims to be extraordinary expenses which does not arise in normal course of business needs to be demonstrated with strict evidence ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO did not take into account remaining amount of expenditure of ₹ 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 ₹ 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 ₹ 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 ₹ 2.54 crores incurred on account of increased cost on account of import of bottom tube from Japan ensure continuous supply thereof is a routine operating expenditure incurred in the course of the business and cannot be treated as abnormal expenditure. The adjustment to the operating profit margin on account of recall of defective products supplied to HSCI, therefore, is to be restricted to ₹ 10,72,32,133 as against ₹ 13,26,32,133 claimed b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oduct 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 extra-ordinary items. The total of extra-ordinary or abnormal items is found to be 2.56 crores which is required to be adjusted for working out profitability of the appellant. 12.8 In view of above, total extra-ordinary cost which is required to be adjusted is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lization is primarily reflected 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 = ₹ 15.23 crores Adjusted depreciation = ₹ 15.23 x 66.12 / 95.12 = ₹ 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such as, raw material cost, power and fuel cost, employees cost, manufacturing expenses, selling expenses, miscellaneous expenses, etc. do not significantly get influenced by the difference in the level of capacity utilization. Such operating expenses are generally commensurate with the volume of production and/or sales turnover and in case there is lower or higher sale, such expenses would correspondingly be increased or reduced. In other words, such operating expenses are normally commensurate with the level of sales. It would also be appreciated that the effect of high or lower capacity utilization is primarily reflected in the charge of depreciation, which is the major item of fixed cost. The increase in operating profit margin of Gabriel on a straight-line basis, directly in proportion to the difference 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. Afte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee as extraordinary cost. Before the ld CIT(A) the assessee submitted that assessee has incurred total cost of ₹ 10.72 crores whereas the TPO considered only the expenses which were incurred by the customer and reimbursed by the appellant. We concur that the assessee over and above the direct expenditure as reimbursement to the customer has other expenditure also in the form of goods lying at the factory. Infact the claim of the assessee is ₹ 13.26 crores out of which the ld Transfer Pricing Officer allowed ₹ 6.11 crores and ld CIT(A) enhanced the deduction to ₹ 10.72 crores. The above facts shows that there is an extraordinary event which has resulted into impacting the overall cost of the assessee. Further, with respect to the overall expenditure the certificate of the appellant shows the total cost at ₹ 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 fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee and the risk of diminution in the value is inherent in any business. Further, the assessee has also not classified it as exception or extra ordinary loss. The inventory has also not been sold. The ld CIT (A) has also gone on estimates without identifying any extra ordinary losss in the inventory but has gone on percentages which is not acceptable. The Differential prices were also calculated by applying the rates of the prouct and not identifying each of the components, which is mandatory at the time of valuation of goods. Assessee before TPO has stated that due to this profit is lowered by 0.79 %. The ld TPO has also given his reason in para no 5.3.3. of his order. He held that no such adjustment was made in Rule 10 D documentation. As the complete fact of the issue, identifying each products and its valuation and consequential shortfall and whether it is an extra ordinary items as per TP documentation is not coming out, Hence this issue is set aside to the file of the ld TPO/AO to decide afresh . Ground no 2 of the appeal is allowed for statistical purposes. 17. Regarding capacity utilization level in the case of the assessee as well as the comparable company, we d ..... X X X X Extracts X X X X X X X X Extracts X X X X
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