2021 (12) TMI 141 - AT - Income Tax

TP Adjustment - main grievance is the non-granting of the adjustment with regard to underutilized capacity - HELD THAT - The settled law is that adjustment on account of capacity utilization has to be granted. In this regard, the TPO is bound to exercise its powers under section 133(6) of the Act and to collate the information on capacity details of comparable companies such as actual capacity in units, installed capacity, breakup of fixed and variable cost, product wise segmental profitability (if any) and provide the assessee opportunity by sharing the details so obtained on the comparable companies. There is want of information / data, adjustment can be made to the tested party also - it would be just and appropriate to set aside the impugned order on this issue and remand the issue to the AO / TPO to carry out the exercise of allowing adjustment on account of underutilized capacity. Not allowing working capital adjustment has been rejected by the DRP but the DRP has given the direction to the TPO / AO to take the margins of the comparables by considering finance cost as non-operating in nature - The directions of the DRP cannot be regarded as substitute for not granting working capital adjustment and therefore we direct the AO / TPO to allow working capital adjustment. Whether transaction of payment of royalty can be aggregated with the international transaction of manufacturing activity also requires afresh look in the light of the submissions made by the learned Counsel for the assessee that the royalty payment as to whether it is linked with the trading segment also has not been verified. Comparables adopted by the assessee in the TP study, it is seen that the DRP has not properly analysed the submissions of the assessee. The 7 comparable companies also are engaged in manufacturing of plastic goods. The DRP has made observation that the assessee is engaged in manufacturing of plastic closures, caps, etc., and therefore the 7 companies are not functionally comparables. There seems to be a contradiction in the order of the DRP - we deem it fit and proper that the issue with regard to determination of ALP should be remanded to the AO / TPO for determination afresh in the light of the observations made by us in this order. AO / TPO shall decide the issue of determination of ALP in the manufacturing segment afresh after affording assessee opportunity of being heard. Accordingly, the order of the AO is set aside and the issue remanded to the AO / TPO.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) in the manufacturing segment.
2. Rejection of Transfer Pricing (TP) analysis by the assessee.
3. Use of multiple year data versus current year data.
4. Inclusion and rejection of comparable companies.
5. Working capital adjustment.
6. Capacity utilization adjustment.
7. Segregation of royalty transaction from manufacturing transaction.
8. Adjustment to the value of international transactions.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) in the manufacturing segment:
The primary dispute involved the determination of ALP for the manufacturing segment of the assessee, who used the Transaction Net Margin Method (TNMM) and computed its operating profit/operating cost (OP/OC) at 7.54%. The Transfer Pricing Officer (TPO), however, recomputed the PLI and arrived at an OP/OC margin of -36.83%, rejecting the assessee's computation.

2. Rejection of Transfer Pricing (TP) analysis by the assessee:
The TPO rejected the assessee’s TP study for using a three-year average of data instead of the current financial year data. The TPO adopted current year data and several other filters, resulting in a set of 37 comparable companies with an average profit margin of 7.84%.

3. Use of multiple year data versus current year data:
The TPO and the Dispute Resolution Panel (DRP) upheld the use of current year data over multiple year data, consistent with the law laid down by the ITAT, Delhi Bench, in the case of Class India Pvt. Ltd.

4. Inclusion and rejection of comparable companies:
The DRP upheld the TPO’s rejection of the seven comparable companies chosen by the assessee, stating that the assessee failed to establish functional comparability. The DRP retained only three of the 37 comparable companies chosen by the TPO, directing the AO to decide the ALP based on a mean margin of 6.92%.

5. Working capital adjustment:
The DRP rejected the assessee's request for a working capital adjustment, reasoning that the TPO had considered finance costs as non-operating, which should suffice. However, the Tribunal directed the AO/TPO to allow the working capital adjustment, stating that the DRP's directions could not substitute for this adjustment.

6. Capacity utilization adjustment:
The DRP and TPO rejected the assessee's claim for a capacity utilization adjustment, citing a lack of detailed evidence. The Tribunal, however, held that adjustment on account of capacity utilization must be granted and remanded the issue to the AO/TPO to gather necessary data and allow the adjustment.

7. Segregation of royalty transaction from manufacturing transaction:
The DRP upheld the TPO’s segregation of the royalty transaction from the manufacturing transaction, adopting the Comparative Uncontrolled Price (CUP) method for the royalty payment. The DRP directed the exclusion of royalty payment from the cost under TNMM and disallowed the royalty payment under section 37 due to lack of evidence.

8. Adjustment to the value of international transactions:
The DRP concluded that adjustments could only be made to the extent of costs debited in the P&L account concerning international transactions. The Tribunal agreed, directing the AO to restrict adjustments in the manufacturing segment to the extent of ?1,19,18,712/- (excluding royalty).

Conclusion:
The Tribunal set aside the impugned order and remanded the issues to the AO/TPO for fresh determination, emphasizing adjustments for underutilized capacity, working capital, and proper analysis of comparables. The appeal was treated as allowed for statistical purposes.