TMI Blog2019 (2) TMI 2023X X X X Extracts X X X X X X X X Extracts X X X X ..... been examined by the tax authorities and since the assessee has to furnish necessary details in order to support its claim, which in turn requires examination at the end of AO, we deem it proper to restore it to the file of the AO / TPO for examining the claim of the assessee. Accordingly, we set aside the order passed by the learned CIT(A) on this issue and restore the same to the file of the AO / TPO for examining the claim of the assessee, in accordance with law, by duly considering the decisions rendered by the High Court / Tribunal on capacity utilization adjustment. After affording adequate opportunity of being heard to the assessee, the A.O. may take appropriate decision in accordance with law. Appeal filed by the assessee is treated as allowed for statistical purposes. - IT(TP)A No.341/Bang/2014 - - - Dated:- 15-2-2019 - Shri N.V.Vasudevan, VP Shri B.R.Baskaran, AM Appellant by : Shri Ketan K.Ved, CA Respondent by : Shri R.N.Siddappaji, Addl.CIT O R D E R Per B.R.Baskaran, AM : The appeal filed by the assessee is directed against the order dated 19.03.2014 passed by learned CIT(A)-IV, Bangalore, and it relates to the assessment year 2004 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the assessee has sought for exclusion of depreciation and fixed cost since the capacity utilization of the company was only 42%. He submitted that the assessee had to incur overhead expenses and provide for depreciation irrespective of the level of capacity actually utilized. He submitted that the higher the capacity utilization, per unit cost allocable out of overheads and depreciation would be lower and vice versa. He submitted that the comparable companies have achieved capacity utilization of 70%. He submitted that the profit margin of the company would be badly affected if the capacity of the assessee is under utilised. Accordingly, the Ld A.R submitted that the depreciation and overheads should be excluded in the case of comparable companies, so that the effect of difference in capacity utilisation is ironed out, which will lead to a meaningful comparison. 5. The Ld A.R submitted that adjustment on account of difference in level of capacity utilization is one of the recognized adjustments. In support of the same, the learned AR placed his reliance on the decision rendered by the Hon ble Bombay High Court in the case of CIT v. Petro Araldite (P.) Ltd. [(2018) 93 tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xtract below the relevant discussions made by the Delhi Bench of the Tribunal:- 6. The second segment of Ground no. 1 of the Revenue s appeal is against the allowing of capacity adjustment in respect of certain items of expenses, which was denied by the TPO. 7. The facts apropos this issue are that the assessee claimed to have worked at a capacity of 29% during the year in question. It was further claimed that the three comparables chosen by it worked at the average capacity utilization of 44%. That is how, the assessee claimed capacity utilization adjustment by reducing its operating costs accordingly. In support of deduction, the assessee filed a report of Mr. Chandra Wadhva, a Cost Accountant. As per this report, the capacity utilization of the assessee as well as the comparables was initially raised to 100%. The TPO partly accepted the claim of the assessee. He considered VST Tractors and Tillers and Punjab Tractors Ltd. (Seg.) for the purposes of allowing capacity adjustment with an average capacity utilization taken at 54%. Thereafter, he restricted the reduction in operating costs of the assessee due to capacity utilization, to some Administrative costs and other expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparables and second, how to compute capacity utilization adjustment under the TNMM. We will deal with these aspects one by one. i. Capacity adjustment should be allowed in whose hands ? 9.1. It has been noticed above that the assessee claimed idle capacity adjustment by reducing its own operating costs. It is further observed that the authorities below have reduced the amount of adjustment by excluding certain costs from the ambit of the costs qualifying for adjustment. However, the adjustment has been ultimately allowed from the operating costs incurred by the assessee. In such circumstances, the question arises as to whether the action of the authorities in allowing the reduction of the operating costs incurred by the assessee, is in accordance with law? In order to find answer to this question, we need to refer to the manner of computation of the arm s length price under TNMM, which has been set out in Rule 10B(1)(e) as under:- (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntrolled transaction shall be comparable to an international transaction, if either there are no differences between the two or a reasonably accurate adjustment can be made to eliminate the material effects of such differences. When we read sub-clauses (ii) (iii) of Rule 10B(1)(e) in juxtaposition to sub-rules (2) (3) of rule 10B, the position which emerges is that the net operating profit margin of comparable companies calls for adjustment in such a manner so as to bring both the international transaction and comparable cases at the same pedestal. In other words, if there are no differences in these two, then the average of the net operating profit margin of the comparable companies becomes a benchmark. However, in case there are some differences between the comparables and the assessee, then the effect of such differences should be ironed out by making suitable adjustment to the operating profit margin of comparables. That is the way for bringing both the transactions, namely, the international transaction and the comparable uncontrolled transactions, on the same platform for making a meaningful and effective comparison. The above analysis overtly transpires that the law ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty utilizations of the assessee vis- -vis comparables, one by one, in the operating profit of comparables by adjusting their respective operating costs. Operating costs can be either fixed or variable or semi-variable. One needs to split semi-variable costs into the fixed part and variable part. In so far as the variable costs and the variable part of the semi-variable costs are concerned, these remain unaffected due to any under or over utilization of capacity. Accordingly, such variable operating costs remain unchanged. The adjustment is called for only in respect of the fixed operating costs and fixed part of semi-variable costs. Such costs are scaled up or down by considering the percentage of capacity utilization by the assessee and such comparable. It can be illustrated with the help of a simple example. Suppose the fixed costs incurred by a comparable (say, A) are Rs. 100 and it has capacity utilization of 50% as against the capacity utilization of 25% by the assessee. The above percentages show that the assessee has incurred full fixed costs with 25% of the utilization of its capacity, as against A incurring full fixed costs with 50% of its capacity utilization. This divulg ..... X X X X Extracts X X X X X X X X Extracts X X X X
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