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TMI Blog2014 (8) TMI 868X X X X Extracts X X X X X X X X Extracts X X X X ..... computing ALP in terms of erstwhile proviso to sec 92C(2) - It has already been decided in earlier cases that assessee while allowing the benefit of ±5% to the assessee as per the erstwhile proviso to 92C of the Act – the order of the CIT(A) allowing the benefit of ±5% adjustment to the assessee while computing the TP adjustment is upheld – Decided against Revenue. Claim of adjustment on capacity utilization – Held that:- Following the order in Dy. Commissioner of Income Tax – Rg. 8(2) Versus M/s Petro Araldite P. Ltd. [2013 (8) TMI 403 - ITAT MUMBAI] - 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 diff ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted was 5.31% as against the OP/OC of the assessee shown at (-2.48%). In this regard, the explanation offered by the assessee before the TPO was that it was operating at 50% of its actual capacity during the year under consideration and therefore its operating profit margin was lower as compared to all the comparables selected. It was pointed out that the capacity utilization of the comparables companies for the year consideration was not available in the public domain and if the same would be taken at 75% and suitable adjustment is made to the profit margin on account of capacity utilization, the adjusted profit margin of the assessee would be 0.93% as against average profit margin of the comparable companies of 5.31%. It was also claimed that the difference between these profit margins being less than 5%, no TP adjustment was required to be made in the case of assessee as per proviso to Section 92C(2) of the Act. The adjustment claimed by the assessee on account of capacity utilization was not allowed by TPO by raising certain doubts about the fixed cost claimed by the assessee. He also did not allow the claim of the assessee for the benefit of 5% adjustment holding that such be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s gotten up to par in terms of quality. This fact also reflects from the financial performance of the appellant company in later years ; in FY 2008-09, the PBIT of the appellant has increased to ₹ 68.01 lakhs and in FY 2009-10 it has further increased to ₹ 214.64 lakhs. (ii) That as the appellant, being a new company in the jewellery market in France, it was very important for the appellant to ensure that its products were of superior craftsmanship and it designs were acceptable to the customers and accordingly there was a lot of reworking/remaking involved to ensure that the products meet the specified quality standards. Further, the appellant was not operating at its full installed capacity and could not absorb its entire fixed costs. Thus, in view of it being in the initial phase of business operations, it had incurred loss. (iii) That in view of the above abnormal phase of its business and large fixed costs sitting in the books of account, and in order to bring out the correct picture of its operational activities, it is necessary to make certain economic adjustments to certain costs while determining the operating margin of the appellant. The appell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,2012 (AY 2006-07) (d) In one of the decisions rendered in the case of Starent Networks (India) P.Ltd 8. In one of the decisions rendered in the case of Starent Networks (India) (P.) Ltd. (supra), the Tribunal has considered and discussed all the relevant aspects of the matter, while allowing the claim of the assessee for the benefits of 5% adjustment as per the proviso to section 92C(2) of the Act as prevalent at the relevant point of time, in paras 20 to 23 of the order which read as under : 20. We have carefully considered the rival submissions. In this case, a pertinent issue which has been vehemently agitated by the appellant is with regard to its claim of seeking benefit of the option available under the erstwhile proviso to section 92C(2) of the Act. The erstwhile proviso which was inserted by Finance Act, 2002 with effect from 1.4.2002 read as under: Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five percent of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the amended Proviso shall govern the determination of ALP in the present case, inasmuch as the amended provisions were on statute when the proceedings were carried on by the Transfer Pricing Officer (TPO). As per the Revenue, the amended Proviso would have a retrospective operation and in any case, would be applicable to the proceedings which are pending before the TPO on insertion of the amended Proviso, which has been inserted by the Finance (No. 2) Act, 2009 with effect from 1.10.2009 and, in this case, the TPO has passed his order on 30.10.2009. The learned Departmental Representative has also referred to the CBDT Circular No 5/2010 (supra) read with Corrigendum dated 30.9.2010 issued by the CBDT in this regard. Per contra, the stand of the assessee is that the amended Proviso would be applicable prospectively and would not apply in respect of the stated assessment year, which is prior to the insertion of the amended Proviso with effect from 1.10.2009. 22. We have carefully examined the rival stands on this aspect. The amended Proviso has been brought on the statute by the Finance (No. 2) Act, 2009 with effect from 1.10.2009. The Explanatory Notes to the provisions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mputing the ALP. 23. However, before parting we may also refer to a Corrigendum dated 30.9.2010 by the CBDT by way of which para 37.5 of the circular No 5/2010 (supra) has been sought to be modified. The Corrigendum reads as under: 16 CORRIGENDUM In partial modification of Circular No. 5/2010 dated 03.6.2010, (i) In para 37.5 of the said Circular, for the lines st the above amendment has been made applicable with effect from 1 April, 2009 and will accordingly apply in respect of assessment year 2009-10 and subsequent years. the following lines shall be read; the above amendment has been made applicable with effect from 1 October, 2009 and shall accordingly apply in relation to all cases in which proceedings re pending before the Transfer Pricing Officer (TPO) on or after such date. (ii) In para 38.3, for the date 1 October, 2009, the following date shall be read: 1 April, 2009 . In terms thereof, it is canvassed that the amended proviso has been made applicable with effect from 1.10.2009 and shall apply even to cases where proceedings were pending before the TPO on or after such date, irres ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relevant period are to be applied and the subsequent circulars either withdrawing or modifying the earlier circulars have no application. Moreover, the circulars in the nature of concession can be withdrawn prospectively only as held by the Hon'ble Supreme Court in the case of State Bank of Travancore v. CIT [1986] 50 CTR 290 (SC). Considering all these aspects, we therefore find no justification in the action of the lower authorities in disentitling the assessee from its claim for the benefit of +/-5% to compute ALP in terms of the erstwhile proviso to section 92C(2) of the Act. We order accordingly.' 9. On the above lines, the Tribunal in other cases also has decided a similar issue in favour of the assessee while allowing the benefit of 5% to the assessee as per the erstwhile proviso to 92C of the Act. The issue involved in the present case in Revenue's appeal thus is squarely covered in favour of the assessee by these decisions of the Tribunal and respectfully following the same, we uphold the order of ld. CIT(A) allowing the benefit of 5% adjustment to the assessee while computing the TP adjustment. 10. As regards the issue involved in the cross-objection f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nner in which the ALP in relation to an international transaction is to be determined by following the transactional net margin method as under: (e) transactional net margin method, by which, (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) The net profit margin realised by the enterprise and referred to in sub-cla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... #8377; 1 crore ₹ 2 crores Profit margin (OP/Sales) 10% 16.67% 25% 21. The above example shows that the profitability changes with the change in the level of capacity utilization with higher profitability at higher utilization and lower profitability at lower realization. This happens mainly because of higher allocation or absorption of fixed overheads at lower capacity utilization which comes down as the level of capacity utilization goes up. For instance, as given in the above example, the rate of allocation or absorption of fixed overheads to sales is 40% at 50% capacity utilization while it becomes 33.33% at 60% capacity utilization and 25% at 80% capacity utilization giving more profit margin of 16.67% at 60% capacity utilization and 25% at 80% capacity utilization as against profit margin of 10% at 50% capacity utilization. The difference in capacity utilization thus 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 requ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ready discussed by us, the difference in capacity utilization affects the profitability mainly because of the difference in rates at which the fixed overheads are absorbed or allocated depending on the level of capacity utilization. The example given by us clearly depicts this position. The said example shows that the allocation of fixed overheads at the capacity utilization of 50%, 60% 80% is 40%, 33.33% 25% respectively resulting in the profit margin of 10%, 16.67% and 25%. In our opinion, if the fixed overheads allocation or absorption of comparable is brought at the level of the assessee , it would nullify the effect of difference in capacity utilization on the profit margin. For example, if we take the profitability working at 50% capacity utilization as that of the tested party and at capacity utilization of 60% and 80% as that of the comparables and adjust the rate of allocation of fixed overheads of the comparables in order to bring the same at par (i.e. 40% of sales) with the tested party, the resultant position will be as under: Net profit Rs.1 crore ₹ 2.00 crores Less additional allocat ..... X X X X Extracts X X X X X X X X Extracts X X X X
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