2015 (12) TMI 1464 - AT - Income Tax

Transfer pricing adjustments - Working capital adjustment to be made while working out the Profit Level Indicator (PLI) - Held that - To bring the uncontrolled transaction comparable to the transactions of an assessee, it is required to eliminate the material differences which are likely to affect the price or cost or profits arising from the transactions. Assessee had given a detailed working capital study of the twelve comparables selected by it and worked-out the average working capital and the ratio of the average working capital to sales of such comparables. There is no case for the Revenue that the comparables considered were not carrying debtors, inventories and creditors. When assessee was not having any debtors and was entirely funded by advance received from AE abroad against supplies, then in order to bring parity between the results of the selected comparables and that of the assessee it is essential that adjustment for the working capital is made on the results of such comparables. Only then can the uncontrolled transaction become comparable to the international transactions of the assessee. In such a situation we are of the view that DRP was correct in giving the direction to the AO to carry out the necessary working capital adjustment in working out the average PLI of the comparables. We do not find any reason to interfere with the order of the DRP. - Decided against revenue Exchange loss / gain - treated as operating in nature for working out the PLI of the assessee - whether there was any nexus between foreign exchange loss / gain with the business activity of the assessee? - Held that - Financial results of the assessee showed that its earnings from export on granite slabs to AE were ₹ 15,55,02,752/-. In our opinion, given this fact situation, foreign exchange gain / loss could have been considered as non-operational only if the AO could show that such gains / loss came out of hedging and transactions which were independent of the business revenue earning transaction of the assessee. The preponderance of probability will always weigh in favour of the assessee when its revenues are only from exports. In such a situation we cannot take a presumption that foreign exchange gain / loss were not having any nexus to the operations of the assessee - Decided against revenue Adjustment for under utilisation of rated capacity not allowed while comparing its results with that of the comparables selected for the TP study - Held that - Depreciation on fixed assets need not be directly proportional to utilisation of machinery. Assets can get depreciated by non usage as well. Hence attempt of the assessee to have a lesser charge of depreciation while working out its PLI in the guise of under utilisation of capacity, in our opinion, was not correct. No doubt, as mentioned by the Ld. AR, Rule 10B(1)(e) requires adjustment of differences between international transactions and the comparable uncontrolled transactions which would materially affect the net material margin. However, assessee here was unable to establish that the comparables had claimed depreciation after considering their capacity utilisation. Further assessee also could not establish the existence of a linear relationship between its depreciation cost and machine utilisation. - Decided against assessee Addition for the working capital adjustment - Held that - Assessee has produced before us a chart according to which the average working capital adjustment that was required to be done for working out the average PLI of the comparables was (-) 2.85%. TPO had however added 2.85% to the unadjusted average PLI of the comparables. We are of the opinion that this issue also requires a fresh look by the AO / TPO. If the working capital adjustment was negative, AO / TPO should rework the adjusted PLI of the comparables after reducing the quantum of such adjustment from the average PLI of the comparables. Ordered accordingly. - Decided in favour of assessee for statistical purpose.

Issues Involved:
1. Working Capital Adjustment while calculating the Profit Level Indicator (PLI).
2. Treatment of Exchange Loss/Gain as Operating in Nature.
3. Adjustment for Underutilization of Rated Capacity.
4. Correct Computation of Working Capital Adjustment.

Detailed Analysis:

1. Working Capital Adjustment while calculating the Profit Level Indicator (PLI):
The Revenue was aggrieved by the directions given by the Dispute Resolution Panel (DRP) on the working capital adjustment to be made while calculating the PLI. The assessee, a subsidiary of a Belgian company, was in the business of manufacturing and exporting cut and polished granite slabs. The Transfer Pricing Officer (TPO) had disallowed the working capital adjustment claimed by the assessee, arguing that such adjustments would emphasize financial activities over operating business activities. However, the DRP directed the Assessing Officer (AO) to compute the mean working capital adjustment for the selected comparables and allow appropriate adjustments. The Tribunal upheld the DRP's direction, emphasizing that adjustments are necessary to eliminate material differences affecting price or profit, as stipulated in Rule 10B(3) of the Income-tax Act. The Tribunal found no reason to interfere with the DRP's order, and grounds 2 to 4 of the Revenue were dismissed.

2. Treatment of Exchange Loss/Gain as Operating in Nature:
The Revenue contested the DRP's decision to treat exchange loss/gain as operating in nature for calculating the PLI. The Tribunal noted that the assessee's revenue was solely from exports, implying that foreign exchange gains/losses were inherently linked to its business operations. Citing a coordinate bench decision in Triology EBusiness Software India P. Ltd v. DCIT, the Tribunal agreed that foreign exchange fluctuations should be considered part of operating revenue. The Tribunal upheld the DRP's direction to treat exchange gains/losses as operational, dismissing grounds 5 and 6 of the Revenue.

3. Adjustment for Underutilization of Rated Capacity:
The assessee was aggrieved that the adjustment for underutilization of rated capacity was not allowed while comparing its results with those of the comparables. The assessee argued that due to economic slow-down and other factors, its capacity utilization was significantly low, leading to higher fixed costs per unit of production. The TPO and DRP rejected this claim, stating that the adverse business environment affected all comparable companies similarly. The Tribunal agreed with the lower authorities, noting that the assessee could not establish a direct relationship between depreciation costs and machine utilization. The Tribunal dismissed grounds 1 and 2 of the assessee.

4. Correct Computation of Working Capital Adjustment:
The assessee contended that the AO incorrectly added the working capital adjustment instead of reducing it while calculating the adjusted average PLI. The Tribunal observed that the working capital adjustment was negative and instructed the AO/TPO to rework the adjusted PLI of the comparables by reducing the quantum of such adjustment from the average PLI. Ground 3 of the assessee was allowed for statistical purposes.

Summary:
The appeal of the Revenue was dismissed, while the appeal of the assessee was allowed for statistical purposes. The Tribunal upheld the DRP's directions on working capital adjustments and the treatment of exchange gains/losses as operational. However, it rejected the assessee's claim for adjustments due to underutilization of capacity but directed the AO/TPO to correct the computation of working capital adjustment.

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