2013 (8) TMI 403 - AT - Income Tax

Transfer pricing adjustments - Book profit for the purpose of MAT (Minimum alternate Tax) - Adjustment for the difference in capacity utilization - Selection of comparables for Transfer Pricing Held that - Out of the two comparables identified by Assessee company , relevant financial data of Sanmar Speciality Chemicals Ltd. for the year under consideration was not available in public domain as admitted by the assessee company also. Therefore, the said company was rejected as comparable. Adjustment for the capacity utilization Held that - The issue of difference in capacity utilisation generally comes in the case of manufacturing concern and like any other business undertaking, the manufacturing concern has mainly two types of overheads i.e. fixed overheads and variable overheads - The variable overheads vary in proportion to the sales and they therefore do not have any effect on the profit margin as a result of difference in capacity utilization. The fixed overheads, on the other hand, do not vary with the volume of sales and since they remain by and large static irrespective of level of capacity utilization, the profit margin gets affected as a result of difference in capacity utilization on this count. Further, the difference in capacity utilization 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. Value of closing stock on account of Excise Duty in terms of provisions of section 145A of the Act Held that - Relying upon the decision in the case of CIT v. Mahalaxmi Glass Works Pvt. Ltd. 2009 (4) TMI 182 - BOMBAY HIGH COURT , it was held that the adjustment on account of Excise/Modvat credit is required to be made as per the provisions of section 145A of the Act in respect of closing stock as well as opening stock. For the purpose of clause (iii) of Explanation 1 to section 115 JB of the Act, one consolidated figure of brought forward losses or unabsorbed depreciation for the earlier years is to be taken or the same is to be considered on year to year basis Held that - Relying upon the decision in the case of Amline Textiles (P) Ltd. v. TPO reported in 2008 (11) TMI 438 - ITAT MUMBAI , it is held that by using the words amount and loss in clause (iii) of Explanation 1 to section 115 JB of the Act, the point has been made clear that it is a composite figure each of the unabsorbed depreciaion and brought forward loss, that merits consideration. - There is nothing in the language of section, which could suggest, even remotely, that the Legislature intended to consider year-wise figures. The lower of the solitary figures of the unabsorbed depreciation or loss brought forward for all the earlier years taken together is to be reduced for the purposes of computing book profit u/s 115 JB of the Act. - Decided against the revenue.

Issues Involved:
1. Transfer Pricing Adjustment
2. Capacity Utilization Adjustment
3. Selection of Comparables
4. Application of Profit Level Indicator (PLI)
5. Adjustment on Account of Excise Duty
6. Computation of Book Profit under Section 115JB

Detailed Analysis:

Transfer Pricing Adjustment:
The Revenue challenged the deletion of an addition of Rs. 5.79 crores made by the Assessing Officer (A.O.) on account of transfer pricing adjustment. The assessee, a joint venture company, had engaged in international transactions with its Associated Enterprises (AEs). The Transfer Pricing Officer (TPO) recalculated the operating profit (OP) by including depreciation and used additional comparables, leading to a higher average OP to total cost (TC) percentage. The TPO's adjustment was based on the difference between the assessee's OP/TC and the average OP/TC of the comparables. The CIT(A) deleted this addition, considering the differences in capacity utilization and rejecting the TPO's comparables.

Capacity Utilization Adjustment:
The CIT(A) upheld the assessee's claim for capacity utilization adjustment, noting the significant difference in capacity utilization between the assessee (65%) and the comparables (over 80%). The CIT(A) accepted the exclusion of depreciation from the operating margin to account for under-recovery of fixed costs due to lower capacity utilization.

Selection of Comparables:
The CIT(A) rejected the three new comparables selected by the TPO, agreeing with the assessee's objections that these companies had significant related party transactions or were functionally different. The Tribunal upheld this decision, noting that the Revenue failed to rebut the CIT(A)'s findings.

Application of Profit Level Indicator (PLI):
The CIT(A) and Tribunal agreed that the PLI should be applied only to the international transactions with AEs, not the entire transactions. This approach was supported by various judicial precedents, which held that the profit margin of comparables should be applied to the value of international transactions to determine the arm's length price (ALP).

Adjustment on Account of Excise Duty:
The issue of adjusting the value of closing stock for excise duty under section 145A was discussed. The CIT(A) directed the A.O. to make adjustments for both opening and closing stock, following the precedent set by the Bombay High Court in CIT v. Mahalaxmi Glass Works Pvt. Ltd.

Computation of Book Profit under Section 115JB:
The Revenue's contention that brought forward losses or unabsorbed depreciation should be considered on a year-to-year basis was rejected. The Tribunal upheld the CIT(A)'s view that a consolidated figure should be used, as supported by the decision in Amline Textiles (P) Ltd. v. TPO. The lower of the consolidated figures of unabsorbed depreciation or brought forward loss for all earlier years is to be reduced for computing book profit under section 115JB.

Conclusion:
The Tribunal partly allowed the Revenue's appeal, specifically reversing the CIT(A)'s decision on the benefit of +/- 5% adjustment under section 92C(2) due to the presence of only one comparable. The other grounds, including the selection of comparables, capacity utilization adjustment, application of PLI, and adjustments for excise duty and book profit computation under section 115JB, were upheld in favor of the assessee.

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