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TMI Blog2013 (8) TMI 403X X X X Extracts X X X X X X X X Extracts X X X X ..... tatic 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 ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st appropriate method to benchmark the above transactions with its AEs and operating profit to sales was taken as PLI. All the transactions with the AEs were aggregated for benchmarking as per the said method and the following two entities were identified as comparables:- 1. Resins Plastics Ltd. 2. Sanmar Speciality Chemicals Ltd. 4. The average PLI i.e. OP to sales of the above two comparables was worked out at 8.54% and the same being less than 12.55% of the assessee, it was claimed that all the international transactions with AEs were at arm's length. 5. When reference was made by the A.O. to the TPO for determining the ALP of the international transactions of the assessee company with its AEs, the TPO found that the OP to sales at 12.55% was worked out by the assessee without deducting depreciation amounting to Rs. 6.15 crores from the operating margin. Since the depreciation was inextricably linked to the production process, the TPO included the depreciation to work out the total operating cost at Rs. 144.13 crores and after deducting the same from the total sales of Rs. 157.80 crores, he worked out the OP of the assessee (before interest and Tax) at Rs. 13 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the addition made by the A.O. on account of transfer pricing adjustment. Before the ld. CIT(A), it was submitted on behalf of the assessee that the TPO completely failed to appreciate the difference in the capacity utilization between the assessee company and the comparable companies. It was submitted that the TPO grossly failed in not considering the adjustment on account of capacity utilization and ignored the effect of under utilization of plant by the assessee which resulted in idle capacity. It was pointed out that the capacity utilization of the assessee was only 65% as against more than 80% capacity utilization in the cases of comparables. 7. The assessee also objected to the new comparable selected by the TPO and made the following submission to show that the companies selected by the TPO were actually not comparable with the assessee company:- "3 M India Limited The company has significant related party transaction and should be rejected. Relate party transactions account for 36% of the total revenue to which the prices at which transactions are entered into may be influence. Hence, this company should be rejected and should not be taken as a comparable to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rds the first issue relating to capacity utilization adjustment, the ld. CIT(A) observed that the cost incurred by any entity are of two types ; variable cost which varies directly with the production level and fixed cost which remains the same irrespective of the production level. He held that since the variable cost varies directly with the production level, its recovery remains uniform irrespective of capacity utilization whereas the fixed cost which remains the same is under recovered as a result of under utilization of capacity resulting in lower profitability. He held that there thus arises need to perform the capacity utilization adjustment and the same can be done by excluding the depreciation which represents fixed cost for the purpose of working out the profit margin of the assessee as well as comparables. He therefore upheld the stand of the assessee to take EBDIT (i.e. Earning Before Depreciation Interest Tax) to sales as operating margin (PLI) for the comparability analysis. According to him, the profit before depreciation rules out any effect on the margin on account of the difference in capacity utilization and the assessee therefore was right in using EBDIT as an ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pany is finally available for the comparability analysis, the assessee cannot claim the benefit of +/- 5% adjustment as per proviso to section 92-C(2) of the Act. In support of this contention, he relied on the decision of the Tribunal in the case of General Atlanta Pvt. Ltd. v. ACIT rendered vide order dtd. 17-5-13 in ITA No. 7638/Mum/2011 and submitted that the decision of the ld. CIT(A) in giving the benefit of +/- 5% adjustment when only one comparable was finally selected by him is contrary to the said decision of the Tribunal. 13. As regards the capacity utilization adjustment, the ld. D.R. contended that such adjustment can be allowed only after ascertaining the reason for low capacity utilization and effect thereof on the profitability. He contended that such adjustment made by the assessee and allowed by the ld. CIT(A) by taking profit margin before depreciation is not correct because depreciation is an integral part of the operating cost which cannot be ignored or excluded while computing the operating profit. He contended that this method followed by the assessee to remove the effect of capacity utilization on the profit margin is a very crude method and the ld. CIT(A) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f authorities below, we no proceed to discuss and decide these issues. SELECTION OF COMPARABLES 16. In the TP study report, the assessee company had identified two comparable companies namely Rasin Plastics Ltd. and Sanmar Speciality Chemicals Ltd. Since the 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, the said company was rejected by the TPO as comparable and there is nothing in the impugned order of the ld. CIT(A) to show that this rejection was disputed by the assessee. As per the fresh search carried out by him, the TPO identified and selected three more companies as comparables viz. 3 M India Limited, Elantas Beck India Limited and Dujodwalla Paper Chemicals Limited and adding these three comparables to Rasin Plastics Ltd. which was identified as comparable by the assessee, the comparability analysis was done by the TPO working out their average OP to TC at 13.50% as against OP to TC of 9.48% in the case of the assessee. The assessee disputed these three new comparables selected by the TPO before the ld. CIT(A) by pointing out that 3 M India Limited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... priate method, benefit of 5% is not available to the assessee. The said decision of the Delhi Bench of the Tribunal in the case of Haworth (India) P. Ltd. (supra) has been followed by the Mumbai Bench of the Tribunal in the case of IIML Asset Advisors Ltd. in ITA No. ITA No. 5173/Mum/2012 wherein it was held that where only one comparable was finally selected by following the appropriate method which was acceptable to both parties and it was possible to recompute the ALP on the basis of even one comparable, the assessee would not be entitled to the benefit of 5% range as per the proviso to section 92C(2) of the Act. In the case of General Atlantic Pvt. Ltd., a similar issue arose again for the consideration of the Tribunal and vide its order dtd. 31-1-2013 passed in ITA No. 8914/Mum/2010, it was held by the Tribunal that even the language of proviso to section 92C(2) of the Act as substituted by the Finance Act, 2009 read with Explanation inserted by Finance Act 2012 with retrospective effect from 1-1-2009 makes it clear that the ALP shall be taken to be in the range of +/- 5% of more than one comparable prices and if there is only one comparable considered in the case, the benefit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o. 428 429 of 2007) and in the case of ACIT v. T Two International Pvt. Ltd. (ITA No. 5644 of 2008). Respectfully following the ratio of these decisions of the co-ordinate Bench of this Tribunal, we uphold the impugned order of the ld. CIT(A) holding that the profit margin of comparables should be applied only to the value of international transactions of the assessee with its AEs to determine the ALP of the said transactions and the TP adjustment has to be worked out on the basis of ALP so determined. Adjustment for the capacity utilization. 19. There being difference in the capacity utilization of the assessee vis- -vis the comparables, adjustment on account of capacity utilization was claimed by the assessee. According to the assessee, if the profit margin is taken before depreciation by adopting Earning Before Depreciation, Interest and Tax (EBDIT) as PLI, the effect of difference in capacity utilization on profit margin can be nullified. The TPO did not approve this method adopted by the assessee for making adjustment on account of capacity utilization whereas the ld. CIT(A) found the same to be acceptable holding that the under utilization of capacity results in un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... endeavor to consider how and to what extent the difference in capacity utilization affects the profit margin and how the adjustment on account of difference in capacity utilization can appropriately be made within the framework of Rule 10B. 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. The under utilization of capacity results in over allocation or over absorption of fixed overheads resulting into under-recovery of fixed overheads which adversely affects the profit margin. As the level of capacity utilization goes up, the rate of allocation or absorption of fix ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... BIT. Although this method adopted by the assessee was not approved by the TPO, it was accepted by the ld. CIT(A) on the ground that the effect of difference in capacity utilization on profitability could be nullified by taking EBDIT as PLI instead of EBIT. We are unable to concur with this view of the ld. CIT(A). In our opinion, when the PLI is taken as OP to sales or OP to cost, operating profit of the assessee as well as comparable cases becomes relevant and the depreciation being very much integral part of the operating expenses of the manufacturing concern, the same cannot be excluded for the purpose of computing operating profit. Moreover, clause (e)(i) of sub Rule (1) of Rule 10-B requires that the net profit margin of the assessee is to be worked out while clause (e)(ii) of the said sub Rule requires that net profit margin of the comparables is worked out. Clause (e)(iii), which permits the adjustments, clearly stipulates that any adjustment on account of differences affecting materially the profitability is to be made to the net profit margin of the comparables as referred to in clause (e)(ii). By taking the net profit margin of the assessee without considering the deprecia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t margin of the said comparables by allocating more fixed overheads at 15% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the comparable would be reduced by Rs. 1.20 crores thereby giving a net profit of Rs. 0.80 crores which would bring the profitability to 10%, i.e. at par with the tested party. Similarly, if the adjustment is made in the profit margin of a comparable having 60% capacity utilization by allocating more fixed overheads at 6.67% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the said comparable would be reduced by Rs. 0.40 crores thereby giving a net profit of Rs. 0.60 crores which would bring the profitability to 10% i.e. at part with the tested party. 25. Having held that the adjustment on account of difference in capacity utilization is required to be made and having explained with illustration that the same can appropriately be made by absorbing or allocating fixed overheads such as depreciation on sales of the comparable at the same rate as that of the tested party, we are of the view that such absorption or allocations of fixed ov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for statistical purpose. 29. The next issue raised by the Revenue in this appeal is whether 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. This issue is raised by the Revenue in ground No. 5, 6 7 which read as under:- "5. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not appreciating the fact that for the purpose of Clause (iii) of Explanation 1 to section 11 5JB, eligibility for deduction is to be considered on year to year basis. 6. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in holding that for the purpose of Clause (iii) of Explanation 1 to section 115JB one consolidated figure of brought forward losses or unabsorbed depreciation for the earlier years in totality is to be taken and not on year to year basis." 7. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not appreciating that the AO had rightly recomputed the Book Profit u/s.115JB by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ather that by using the words 'amount' and 'loss' in this clause, the point has been made clear that it is a composite figure each of the unabsorbed and brought forward loss, that merits consideration. Moving still further we find from the language of this clause that there is no reference to considering the brought forward loss or unabsorbed depreciation on year to year basis. There is nothing in the language of section, which could suggest, even remotely, that the Legislature intended to consider year-wise figures. If it had desired like that, then it would have been so stated in unequivocal terms in the provision itself. In the absence of any specific mention in this regard in the clause, we are unable to infer such intendment. Since the language of the section is clear and does not admit of any doubt, we are not persuaded to interpret it in the way, the ld. D.R. impresses upon us to do." 31. Respectfully following the decision of the coordinate bench of this Tribunal in the case of Amline Textiles (P) Ltd. (supra), we uphold the impugned order of the ld. CIT(A) holding that the lower of the solitary figures of the unabsorbed depreciation or loss brought forward for all the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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