2015 (8) TMI 977 - AT - Income Tax

Transfer pricing adjustment - low utilization of capacity - Held that - In order to arrive at an appropriate adjustment, the entire factual matrix is required to be examined at the appropriate level. The TPO as well as the DRP did not accept the plea of the assessee in principle, while the same has been accepted by us. Therefore, in order to allow an appropriate adjustment, necessary verification on the basis of the material to be furnished by the assessee, deserves to be carried out by the Assessing Officer. Therefore, while upholding the plea of the assessee, we restore the matter back to the file of the Assessing Officer who shall allow the assessee a reasonable opportunity to make submissions and produce relevant material in support of its stand and thereafter the Assessing Officer shall allow an appropriate adjustment in the operating margins of the assessee for low capacity utilization and high fixed operating costs incurred in the initial year of operation. - Decided in favour of assessee for statistical purposes. Computation of assessee s margin for the purposes of comparability analysis - As per the assessee, future year s actual margins be also considered to determine its profit margins in order to determine the ALP. The aforesaid plea is sought to be justified on the basis that due to exceptional circumstances of being the initial year of set-up, the assessee has incurred loss during the year, while it has earned profits in the subsequent two years. Therefore, assessee submitted that future year s actual margins be also considered for analyzing the comparability of current year s margin with the comparable uncontrolled transactions. The TPO as well as the DRP have not accepted the plea of the assessee and held that having regard to rule 10B(1)(e) of the Rules, there is no scope to consider data of the subsequent assessment years. In our considered opinion, the assessee has to fail on this aspect for the reasons assigned by the lower authorities. Also the earning of profits in the future two years by the assessee may be a good ground to justify the loss being incurred in this year because of the exceptional circumstances of being the initial year of set-up, under capacity utilization, etc., but there is no justification for inclusion of the future year s profit margins while determining the ALP of the current year s international transactions. - Decided against assessee. Non providing adjustment on account of working capital differences vis- -vis the comparable uncontrolled entities - Held that - We are inclined to remit the matter back to the file of the Assessing Officer who shall examine as to whether or not in the present case the working capital requirement constitute an item of difference so as to require adjustment as per the para-meters laid down by rule 10B(1)(e)(iii) r.w.rule 10B(3) of the Rules for the purposes of analyzing the comparability of the comparable uncontrolled transactions with the international transactions of the assessee. Needless to say, the Assessing Officer shall allow the assessee a reasonable opportunity to put-forth material and submissions - Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Adjustment for low capacity utilization and high fixed operating costs.
2. Consideration of future years' actual margins for determining ALP.
3. Adjustment for working capital differences.
4. Computation of ALP considering +/- 5% variation.

Detailed Analysis:

1. Adjustment for Low Capacity Utilization and High Fixed Operating Costs:
The assessee, a 100% Export Oriented Unit engaged in manufacturing water heaters, declared a loss due to low capacity utilization (21%) and high fixed operating costs in its initial year of operations. The Transfer Pricing Officer (TPO) and Dispute Resolution Panel (DRP) did not accept the assessee's plea for adjustments on account of these factors, arguing that adjustments are permissible only with respect to the net profit margin of comparable uncontrolled transactions as per Rule 10B(1)(e) of the Income Tax Rules, 1962. However, the Tribunal held that the assessee's economic and commercial reasons for adjustments were valid and warranted an appropriate adjustment to facilitate a meaningful comparability analysis. The Tribunal directed the Assessing Officer to allow the assessee an opportunity to provide relevant material and make appropriate adjustments for low capacity utilization and high fixed operating costs.

2. Consideration of Future Years' Actual Margins for Determining ALP:
The assessee argued that future years' actual margins should be considered to determine the Arm's Length Price (ALP) due to the exceptional circumstances of the initial year. The TPO and DRP rejected this plea, referencing the Tribunal's decision in Honeywell Automation India Ltd. vs. DCIT, which held that Rule 10B(1)(e) does not allow consideration of subsequent years' data. The Tribunal affirmed the lower authorities' decision, stating that future years' profits cannot be included in determining the ALP for the current year's transactions.

3. Adjustment for Working Capital Differences:
The assessee raised the issue of not being provided adjustments for working capital differences vis-`a-vis comparable uncontrolled entities. Although this plea was not raised before the TPO, it was presented before the DRP. The Tribunal noted that adjustments for working capital differences are permissible under Rule 10B(1)(e)(iii) read with Rule 10B(3) of the Income Tax Rules. The Tribunal remitted the matter back to the Assessing Officer to verify whether working capital requirements constitute an item of difference requiring adjustment and directed the Assessing Officer to allow the assessee to submit relevant material for this purpose.

4. Computation of ALP Considering +/- 5% Variation:
The assessee contended that the lower authorities erred in computing the ALP of international transactions without considering the permissible +/- 5% variation as per Section 92C(2) of the Income Tax Act. The Tribunal noted that the assessee did not articulate this grievance during the hearing, primarily due to amendments made by the Finance Act, 2012. The Tribunal directed the Assessing Officer to revisit this issue in light of the legal position emerging from the amendments to Section 92C.

Conclusion:
The Tribunal directed the Assessing Officer to re-determine the ALP and international transactions based on the discussed adjustments for low capacity utilization, high fixed operating costs, and working capital differences, while also revisiting the issue of +/- 5% variation. The appeal of the assessee was partly allowed.