TMI Blog2022 (3) TMI 1528X X X X Extracts X X X X X X X X Extracts X X X X ..... . Capacity adjustment - We find that the settled law is that adjustment on account of capacity utilization has to be granted. The additional evidence now produced go to the root of the issue of determination of ALP on the manufacturing segment. For a proper adjudication of the issue and for substantial cause, the same is admitted and taken on record. Accordingly, we set aside the issue to the file of the AO / TPO, directing to follow the directions given in the case of IKA India Private Limited [ 2018 (10) TMI 49 - ITAT BANGALORE ] Foreign exchange fluctuations adjustment - TPO and the DRP have not properly analysed the submissions of the assessee. There is no analysis whether there was any adverse foreign exchange fluctuations during the relevant assessment year, which is abnormal in nature and what is its effect on the operating margin of the assessee and the comparables. These aspects needs to be analysed - it would be just and appropriate to set aside the impugned order on this issue and remand the issue to the TPO. Impairment of loss - We observe from financial statement, that the agreement to sell is entered into on February 24, 2014 and effective date of sale ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xclusion of companies as functionally dissimilar with that of assessee ITES segment. Working Capital Adjustment - ITES segment - HELD THAT:- Respectfully following the decision of Huawei Technologies India (P.) Ltd. [ 2018 (10) TMI 1796 - ITAT BANGALORE ] we also hold that the working capital adjustment is to be allowed as per actuals, after considering the decisions rendered in this order on the exclusion/inclusion of comparable companies out of/into the final set of comparables. The TPO/ AO are accordingly directed. After proposing the TP adjustment on account of management fees, the DRP suo moto proposed disallowance of the same management fees u/s 37 - assessee has not furnished the details of the expenses - HELD THAT:- We are of the view that the protective disallowance of management fees u/s 37 of the I.T. Act needs to be considered afresh since the issue of transfer pricing adjustment of management fees has already been remitted back to the AO/TPO for fresh examination. - IT(TP)A No. 103/Bang/2019 And IT(TP)A No. 790/Bang/2019 - - - Dated:- 22-3-2022 - Shri George George K, JM And Ms. Padmavathy S, AM For the Appellant : Sri. K.R. Vasudevan, Advocate. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s including high performance identification tapes, die-cut products etc. The segmental details of the manufacturing and other segment as per the TP documentations, have been extracted at para 3.1 of the TP order. The TPO has recomputed the segment details for the three segments, which is at para 3.2 of the TP order. The essential difference between the segmental details as computed by the assessee (para 3.1 of the TP order) and as recomputed by the TPO (para 3.2 of the TP order) are as under:- (i) The assessee has made adjustment for capacity utilization (capacity taken as 60%), whereas the TPO has disregarded the adjusted capacity utilization and considered the full amounts. (ii) The assessee had taken adjustment for Forex fluctuation (1,91,82,480) whereas the TPO has not considered the adjustment. (iii) The TPO has added an amount of Rs.97,19,858 towards exchange loss, which means he had considered this amount as not part of operating expenses. (iv) The TPO has added an amount of Rs.1,73,89,263 towards impairment loss, which means he had considered this amount as not part of operating expenses. (v) The TPO has taken the segmental apportionment as 56.35%, 8.29%, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 276. (ii) The assessee s another grievance is non-granting of the adjustment with regard to underutilization of the capacity. The learned AR has submitted that it had idle capacity to the extent of 40% during the year. The assessee has submitted that the capacity was underutilized due to slumping the market and subsequent closure of Nokia business. The TPO has not allowed capacity utilization adjustment on the ground that adjustment has to be computed on the tested party and not on the comparables. The assessee relied on the order of ITAT in the case of IKA India Private Limited (supra) and submitted additional evidence providing computation of capacity utilization adjustment as outlined in the Tribunal decisions. (iii) The learned AR submitted that due to adverse foreign exchange fluctuations, import cost of raw materials from Bradley group companies and third parties have increased considerably. The assessee has submitted that increase in import cost could not be passed on to the end customer due to competitive environment in the industry. The assessee has therefore claimed economic adjustment towards Forex fluctuations. The assessee has relied on the order of the ITAT in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tunity of hearing to the assessee. 4.6.1 On the issue of capacity adjustment, we find that the settled law is that adjustment on account of capacity utilization has to be granted. In this regard, the Bangalore Bench of the Tribunal in the case of IKA India Private Limited (supra) has held as follows [Bangalore Bench followed its earlier order in IKA India Private Limited s case for assessment year 2012-2013 in IT(TP)A No.2192/Bang/2017 (order dated 17.09.2018)]. The relevant finding of the Tribunal in case of IKA India Private Limited for assessment year 2012-2013 reads as follows:- 22. We have heard the submissions of the assessee and the ld. DR on the issue raised by the assessee in ground No.7. We shall first see the statutory provisions relevant to the issue. Rule 10B(1)(e) of the Rules states that adjustments should be made to account for: ...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 23. Rule 10B(2) of the Rules provides comparability of an internatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties. Further, Para 2.74 of the OECD Guidelines while laying down the comparability criteria to be adopted while applying the transaction net margin method states as follows: .. Thus where the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method' (Emphasis supplied) 27. US transfer pricing Regulations on this aspect is as follows:- In addition, the US transfer pricing regulations, u/s 482 of the Internal Revenue Code (hereinafter referred to as 'the US regulations') also support the above. Regulation 1.482-1(d)(2) of the US regulation states as follows: In order to be considere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment. (iii) In the case of Biesse Manufacturing Company Limited (IT(TP) A Nos. 97 493/Bang/2015) for AY 2010-11, the Tribunal held as follows: 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 of computation thereof and the quantum of adjustment...... 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 under-utilisation can be granted .. Fol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don t restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/transactions as per subclause (i) of rule 10B(1)(e) of the Rules itself. The absence of specific provision in Rule 10B(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been upheld in the following decisions:- Capegemini India Pvt. Ltd. (ITA No.7861/Mum/2011) Demang Cranes Components (India) Pvt Ltd. [49 SOT 610 (Pune)] 32. As far as data of comparable companies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilizatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 133(6) of the Act to call for information on capacity utilization of the comparable companies such as Installed Capacity, Actual Production in Units, Break-up of Fixed Cost and Variable Cost; Segmental/ product wise information, if any. 36. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No.7 is decided accordingly. 4.6.2 The assessee has also produced as additional evidence, computation of capital utilization adjustment as stated in the above judicial pronouncements. The additional evidence now produced go to the root of the issue of determination of ALP on the manufacturing segment. For a proper adjudication of the issue and for substantial cause, the same is admitted and taken on record. Accordingly, we set aside the issue to the file of the AO / TPO, directing to follow the directions given in the case of IKA India Private Limited (supra). 4.6.3 On the issue of foreign exchange fluctuations adjustment, we observe that the TPO and the DRP have not properly analysed the submissions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tested party Rate Arm s length price / margin Brady Corporation Asia Pacific Pte Ltd. (Brady Singapore) Brady Singapore 5% 8.54% Brady Worldwide Inc (BWW) BWW At cost 9.06% 5.1 The TPO had apparently accepted the ALP of the management fee transaction, as no adjustment was proposed by him in the TP order. However, the DRP suo moto decided that the ALP of this transaction as Nil and directed the AO / TPO to add the entire amount as adjustment. 5.2 Aggrieved, the assessee has raised this issue before the ITAT. It was submitted that the DRP was wrong, both on facts and on legal principles. The submissions of the learned AR in brief are summarized as follows:- (i) No opportunity provided to assessee by DRP. The assessee submits that the TPO had issued a show cause notice in connection with management fees, to which the assessee had responded with its detailed submission and supporting evidences. The TPO did not propose any adjustment (SCN at page 702 of PB). During the course of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of payment of management fees can be aggregated with the international transaction under the manufacturing segment also requires a fresh look in the light of the submissions made by the learned AR (since management fees is directly linked with the operation of the assessee). This aspect has not been analysed in a proper perspective. In these given facts and circumstances of the case, we deem it fit and proper that the issue of determination of ALP of the management fees be remanded to the AO / TPO for fresh determination. The AO / TPO shall afford the assessee reasonable opportunity of being heard before a decision is taken in this matter. It is ordered accordingly. 5.5 In the result, grounds 14 to 22 are allowed for statistical purposes. ITES Segment (Grounds 23 to 34) (TP adjustment) 6. Brief facts in relation to ITES segment are as follows: It is stated that the assessee has maintained full segmental details of the three segments, namely, manufacturing segment, trading segment and service segment. The segmental details of ITES segment is at para 3.1 of the TP order. However, the TPO disregarded the segmental details and revised the same as given in para 3.2 of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inclusion. 6.2.1 The assessee objected to the inclusion of this company, on the following grounds:- (a) Functionally diversified Provides high end and end-to-end outsourcing services in the nature of business process management. Engaged in providing cloud based services such as `E-Discover as well as services in relation to compliance in Health, Safety and Environment. (b) Different business model consultancy expenses in the nature of sub-contracting charges. (c) Presence of intangible assets and intellectual properties. (d) Significant brand value and performs brand building functions. (e) Higher scale of operations. 6.2.2 We have heard rival submissions and perused the material on record. The Bangalore Bench of the Tribunal in the case of M/s.Ocwen Financial Solutions Private Limited (supra), had excluded M/s.Infosys BPO Limited from the list of comparable company. The relevant finding of the Bangalore Bench of the Tribunal, reads as follows:- 7.4.1 We have considered the rival contentions / submissions and perused the material on record; including the judicial decisions cited. We find from a perusal of the Annual Report at page 14 thereof, under t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... file of the assessee in the case of M/s.Ocwen Financial Solutions Pvt. Ltd.(supra) being similar and the assessment year also being the same, i.e. A.Y. 2014-2015, we hold that the finding of the co-ordinate Bench order in the case of M/s.Ocwen Financial Solutions Pvt. Ltd. (supra) will have application to the facts of the instant case. Therefore, we direct the AO/TPO to exclude Infosys BPO Limited from the list of comparables. It is ordered accordingly. Microland Ltd., ('Microland') 7. This company 'Microland' was selected as a comparable company by the TPO despite the objections to its inclusion in the final list of comparables both before the TPO and DRP. 7.1 The assessee has objected to the inclusion of this company 'Microland' on the following grounds:- (a) Erroneous computation of margin ought to have considered the ITeS segment instead of entity level which includes infrastructure management services. Correct margin is 9.98%. (b) Fails service income filter applied by the TPO (ITes income of only 5.68%) (c) Significant R D activities. (d) Extraordinary growth during the year (growth of 43%) (e) Higher scale of operations. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s different from the back office processing services rendered by companies like the assessee in the case on hand. In our view, there is no basis for the TPO to contend that the aforesaid services rendered by Microland are ITES, when the company itself has classified these services as different from ITES and characterized the same as a different business segment. In these factual circumstances, we are inclined to concur with the contention of the learned AR that the Infrastructure Management services segment of Microland is different and distinct with ITES as has been classified by the company in its Annual Report for the year under consideration. We also observe that the TPO himself has reached the same conclusion n the subsequent Assessment Year 2015-16; that the Infrastructure segment services segment is not comparable to ITES. 8.4.4 At page 97 of the Annual Report of Microland for the year under consideration, the segmental details of the two business segments are provided from which it is seen that out of the total revenue of Rs.34,471 lakhs, the revenue from ITES segment is Rs.1959 lakhs; which is 5.68% of the total revenue. As we have concluded that the infrastruc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al Report of Informed it is seen that the total revenue is shown as Rs.3,81,38,665/- and other income of Rs.1,22,85,303/-. As can be seen from Schedule 19 on page 40 of the Annual Report, the other income comprises of non-operating income, interest, dividend, sale of current investments and miscellaneous income and evidently these incomes cannot be considered as operating income. The percentage of 67.7% worked out by the TPO is after considering these other income as service income; which is factually incorrect. It is evident from a perusal of the profit and loss account of Informed that the service income is Rs.2,58,53,362/- which is entirely the revenue from operations and therefore in our considered view, the service income filter of 75% of service income to be from ITES as applied by the TPO, is satisfied in this case. In view of this factual finding rendered in the matter, we hold that this company Informed Technologies Ltd., satisfies the service income filter and is therefore to be included in the final set of comparables. We hold and direct the AO/TPO accordingly. 8.3.1 In the light of the order of the co-ordinate Bench of the Tribunal, we hold that the AO/T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d (`Jindal ) 10. The assessee has objected to the exclusion of this company Jindal Intellicon Limited for the following reasons:- (a) Call center services would be classified under ITeS. (b) As the company is operating in only one segment ITeS, no segmental data is required. 10.2 The learned AR relied on the order of the ITAT in the case of M/s.Ocwen Financial Solutions Private Limited (supra). 10.3 We have heard rival submissions and perused the material on record. The Bangalore Bench of the Tribunal in the case of M/s.Ocwen Financial Solutions Private Limited (supra), had included Jindal Intellicon Limited in the list of comparable company. The relevant finding of the Bangalore Bench of the Tribunal, reads as follows:- 12.4.1 We have considered the rival contentions / submissions put forth and perused the material on record. We have also perused the Annual Report of this company, Jindal ; which is placed at pages 498 to 975 of the paper book. At page 130 of the Annual Report (i.e., page 627 of the paper book), it is mentioned that the company is engaged in providing call centre services, both in the overseas and domestic market; export of call centre servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable companies. Accordingly, we direct the AO/TPO to include Jindal Intellicom Limited in the list of comparables. 10.3.2 In the result, ground 24 is partly allowed. Working Capital Adjustment (Ground 26) 11. The next grievance of the assessee in the ITeS segment is in respect of not granting of working capital adjustment. 11.1 We have considered the rival submissions and perused the material on record, including the judicial pronouncement cited. We find that the assessee has filed the computation of working capital adjustment before the DRP; but the DRP has not considered the same. We also find that the Co-ordinate Bench of this Tribunal in the case of Huawei Technologies India (P.) Ltd. 101 taxmann.com 313 has discussed all the reasons on the issue and held that working capital shall be allowed; holding as under at paras 10 to 18 thereof- 10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT (A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act insofar as comparability of international transaction with a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions: (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic 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. 11. A reading of Rule 10B(1)(e)(iii) of the Rules read with Se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect. 15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential com parables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions and assumptions may not lead to reliable results. 16. The CIT (A) also placed reliance on a decision of Chennai ITAT in the case of Mobis India Ltd. v. Dy. CIT [2013]38 taxmann.com 231/[2014] 61 SOT 40. That decision was based on the factual aspect that the assessee was not able to demonstrate how working capital adjustment was arrived at by the Assessee. Therefore nothing turns on the decision relied upon by the CIT (A) in the impugned order. In the matter of determination of Arm's Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm's Length Price. The data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed out in these working by the CIT (A). We may also further add that in terms of Rule 108(l)(e)(iii) of the Rules, the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions which could materially affect the amount of net profit margin in the open market. It is not the case of the CIT (A) that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by CIT(A) working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 108(3) of the Rules, which provides as follows: (3) An uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transacti ..... X X X X Extracts X X X X X X X X Extracts X X X X
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