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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 ..... 07 declaring loss of Rs. 88,24,570/-. During the course of assessment proceedings, it was noticed by AO from the transfer pricing study report submitted by the assessee that the assessee has entered into various international transactions with its Associated Enterprises (AE) including transactions involving export of studded jewellery to its AE worth Rs. 12,77,59,946/-. He, therefore, made a reference u/s 92CA(1) of the Income Tax Act, 1961 (the Act) to the TPO for determining the Arm's length price of the said international transactions. During the course of proceedings before him, the TPO found that the average profit margins (OP/OC) of the comparable selected 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 adju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pieces, 152,536 pieces, 137,746 pieces in FYs 2007-08, 2008-09 and 2009-10 respectively. The manpower was employed commensurate with the installed capacity as they had to be trained and therefore, it incurred high manpower cost and fixed overheads which led to high production cost. In view of it being only the second year of operations, re-making cots having been incurred, under utilization of capacity, high manpower costs and fixed overheads, etc, the appellant had incurred loss during the FY relevant to the assessment year under consideration; (i) That, however, the later years the appellant company has managed to achieve break-even point in terms of sales and has 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 Rs. 68.01 lakhs and in FY 2009-10 it has further increased to Rs. 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 wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7. We have heard the arguments of both the sides and also perused the material available on record. As regards the issue involved in the appeal of the revenue relating to the benefit of +/-5% adjustment allowed by ld. CIT(A) as per proviso to section 92C(2) of the Act, it is observed that the same is squarely covered in favour of the assessee inter alia by the following decisions of the Tribunal : (a) Amdocs Business Services (P) Ltd V/s DCIT in T Appeal No.1412 (Pune) of 2011 dated July 23,2012 (AY-2007-08); (b) tarent Networks (India) P.Ltd V/s DCIT in ITA No.1350/PN/2010, (AY-2006-07) order dated 3.10.2011; (c) ata Vectra Motors Ltd V/s DCIT in IT Appeal No.1284(Bang) of 2010 dated January 31,2012 (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 sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er, the other argument set up by the Revenue and which has been more potently argued is to the effect that the benefit of such Proviso is not available to the assessee in the instant case, because the said Proviso has been amended by the Finance (No 2) Act, 2009 with effect from 1.10.2009 which reads 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: Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm's length price." The case set up by the Revenue is that 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... must apply to the assessment of the year and the modification of the provisions during the pendency of assessment would not generally prejudice the rights of the assessee. Furthermore, we are fortified by the intention of the Legislature as found from circular No 5 of 2010 (supra) whereby in para 37.5, the applicability of the above amendment has been stated to be with effect from 1.4.2009 so as to apply in respect of assessment year 2009-10 and subsequent years. In this regard, we also find that the Delhi Bench of the Tribunal in the case of ACIT v. UE Trade Corporation India (P.) Ltd. vide ITA No 4405(Del)/2009 dt 24.12.2010 has observed that the proviso inserted by the Finance (No 2) Act, 2009 would not apply to an assessment year prior to its insertion. In this view of the matter, we therefore find no justification to deny the benefit of +/-5% to the assessee in terms of the erstwhile Proviso for the purposes of computing 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No 5/2010 (supra) were in operation. In other words, the withdrawal of the interpretation placed in circular No 5 /2010 (supra) on the applicability of the amended proviso is sought to be done away by the Corrigendum dated 30.9.2010 and, therefore, such withdrawal shall be effective only after 30.9.2010, even if such Corrigendum is accepted as valid. We may note here that the appellant has assailed the validity of the Corrigendum itself on which we have not made any determination. Therefore, the Corrigendum dated 30.9.2010, in our considered opinion, has no bearing so as to dis-entitle the assessee from its claim of the benefit of +/-5% in terms of the erstwhile proviso to section 92C(2) of the Act. In coming to the aforesaid, we have been guided by the parity of reasoning laid down in the judgments of the Hon'ble Bombay High Court in the cases of BASF (India) Ltd. v. Hasan, CIT [2006] 280 ITR 136; Shakti Raj Films Distributors v. CIT [1995] 213 ITR 20 (Bom); and, Unit Trust of India v ITO [2001] 249 ITR 612 (Bom). The Hon'ble High Court has opined in the case of BASF (India) Ltd. (supra) that the circulars which are in force during the relevant period are to be applied an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 under recovery of fixed expenses like depreciation and if the depreciation is excluded, the effect of difference in capacity utilization on profit margin can be nullified. Before we proceed to deal with the issue of adjustment for difference in capacity utilization, it is necessary first to see the procedure laid down for carrying out the exercise of comparability analysis and making suitable adjustments. This procedure as laid down in section 92-C of the Act provides that the ALP in relation to an international transaction shall be determined by any of the methods specified therein, being the most appropriate method and the manner in which the said ALP has to be determined is given in section 92-C(2) of the Act read with Rule 10B of the Income Tax Rules, 1962 in respect of each method separately. Clause (e) of Rule 10-B stipulates the manner in whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ince 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 fixed overheads to sales comes down resulting into higher profit margin. The following simple example would further explain this position: Installed capacity in monetary terms Rs.10 crores Rs. 10 crores Rs. 10 crores Capacity utilisation 50% 60% 80% Sales Rs. 5 crores Rs. 6 crores Rs.8 crores Variable overheads at 50% Rs.2.5 crores Rs.3 crores Rs. 4 crores Fixed overheads Rs.2 crores Rs. 2 crores Rs. 2 crores Net profit Rs.0.5 crores Rs. 1 crore Rs. 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ked 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 depreciation in order to make adjustment on account of difference in capacity utilization, what the assessee has sought to do is to make adjustment to the net profit margin of the assessee as referred to in clause (e)(i) of sub Rule (1) of Rule 10B, which in our opinion, is not permissible in accordance with clause (e)(iii) of sub Rule (1) of Rule 10B. 23. The question that now arises is what is the proper method of making adjustment for difference in capacity utilization within the frame work given in Rule 10B. As already 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 alloca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ence 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 overheads on operating cost instead of sales would be more appropriate as the same will eliminate the effect of difference in profit margin or difference in level of stock of finished goods, if any, of the tested party and comparables.' 11. Keeping in view the decision of the Tribunal in the case of Petro Araldite (P.) Ltd. (supra) laying down the guidelines on the issue of capacity utilization, we consider it appropriate to restore this issue relating to adjustment on account of capacity utilization in the case of assessee company to the file of AO/TPO for deciding the same afresh keeping in view the said guidelines. If the exact details of capacity utilization of the comparable companies are not available in the public domain, the AO/TPO is directed to obtain the same directly from the concerned parties and to decide this issue afresh after giving a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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