9911796707
TMI Blog2016 (3) TMI 1121X X X X Extracts X X X X X X X X Extracts X X X X ..... der TNMM - Held that:- the capacity utilization adjustment has to be granted where there has been under utilization or lower utilization of the capacity. In the facts of the present case, we deem it appropriate to remit the issue back to the file of Assessing Officer to decide this issue afresh after considering the submissions of the assessee, documents on record and decisions of the Tribunal. Accordingly, ground no. 2 raised in the appeal is allowed for statistical purpose. Selection of comparable - Held that:- the comparables F I Sofex Limited and Fortune Informatics Limited although were having loss in the year of comparison but whether they were consistent loss making companies has not been ascertained by the TPO before rejecting the same. A company is said to be bad comparable if it is a consistent loss making entity. Accordingly, we are of the opinion that this issue needs a revisit to the Assessing Officer. The Assessing Officer after considering the submissions of the assessee and documents on record shall decide the issue afresh in the light of the decisions discussed above. Accordingly, this ground of appeal of the assessee is allowed for statistical purpose. Benef ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsactions were relating to the activity of providing IT enabled services. For benchmarking the transactions and determining Arm s Length Price (ALP) the assessee adopted Transactional Net Margin Method (TNMM) as the most appropriate method. For applying TNMM the assessee used Profit Level Indicator (PLI) of Operating Margin/Operating Revenue . In the TP report the assessee shows loss of 2.09% on sales as compared to the arithmetical mean of the operating margin to sales of the comparable companies, considering average for three years, at 4.85%. 2.1 The assessee while determining operating profit made adjustment for the under utilization of the working capacity at 29% and under utilization of manpower by 40%. After making the adjustment the assessee reworked its operating margin on sales at 14.71%. However, the TPO rejected the adjustment made by the assessee in its operating profit on account of under utilization of capacity and manpower. Further, from the list of comparable companies furnished by the assessee, the TPO excluded F I Sofex Limited and Fortune Informatics Limited on the ground that both the companies are extreme loss making companies having operating margin ratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Transfer Pricing analysis 3.1 The honorable CIT (A) erred on the facts and in circumstances of the case in confirming the rej ection of the independent comparable companies F I Sofex Ltd. and Fortune Informatics Ltd. (now known as Intense Technologies Ltd .) selected by the Appellant in its Transfer Pricing. 4. Transfer pricing adjustment without giving benefit of +/- 5 per cent as available under proviso to section 92C(2) of the Act 4.1 The honorable CIT (A) erred on the facts and in circumstances of the case and in law in making the transfer pricing adjustment from the arm's length price without, giving the benefit of the option available to the Appellant under proviso to section 92C(2) of the Act. 5. Each one of the above grounds of appeal is without prejudice to the other. 6. The Appellant reserves the right to amend, alter or add to the grounds of appeal. 4. Shri Shri Ketan Ved and Shri Vishal Solanki appearing on behalf of the assessee submitted that the authorities below have erred in not granting the capacity under utilization adjustment. The ld. AR submitted that while calculating operating margin the fixed costs have been adjusted to the extent o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decided on 12-08-2015. 4.1 The ld. AR further submitted that the authorities below have erred in excluding F I Sofex Limited and Fortune Informatics Limited from the list of comparables on the ground that they are loss making companies. Whereas a perusal of year wise details of operating margin ratio of both the entities at page 293 of the paper book would show that out of 7 years ( from 1999-00 to 2005-06) the aforesaid companies have earned profits in 4 years. Up to the period relevant to the assessment year 2004-05 both the comparables have losses in 2 years only. To be considered as a consistent loss making company, the company should have incurred losses in 3 consecutive financial years, which is not the case in the aforesaid comparables. The ld. AR further referred to the table at page 314 of the paper book to show that the said companies had positive net worth in the years under consideration and were not sick enterprises. Both the companies had incurred normal business losses as a part of their operations. The ld. AR submitted that in these circumstances the action of the TPO in rejecting the comparable entities on the basis of loss making companies is not appropriate. A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gin. 6. The ld. AR of the assessee controverting the submissions made on behalf of the Department submitted that under utilization capacity adjustment is to be made on comparables and not on the tested party. The ld. AR fairly admitted that ground no. 4 raised in the appeal relating to 5% safe harbour has to be decided against the assessee in view of the amended provisions of section 92C of the Act. 7. We have heard the submissions made by the representatives of rival sides and have perused the orders of the authorities below. We have also considered the decisions on which the ld. AR of the assessee has placed reliance to support his submissions. The assessee in its appeal has raised 6 grounds. Ground Nos. 1, 5 and 6 are general in nature. Hence, require no adjudication. Thus, the effective grounds raised in the appeal are 2, 3 and 4 only. 8. In ground no. 2 the assessee has assailed the findings of Commissioner of Income Tax (Appeals) in upholding the order of Assessing Officer in rejecting functional (capacity utilization) adjustment. The contention of the assessee is that during the period relevant to the assessment year under consideration the assessee has expanded i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Income Tax (Appeals) rejected the contentions of the assessee merely on the ground that the assessee is a captive unit of holding AE, therefore, the entire production capacity will be monitored and utilized by the holding company alone. The TPO and the Commissioner of Income Tax (Appeals) have erred in not examining the factual aspect of increase in output capacity before rejecting functional adjustment made to the PLI. The contention of the assessee is that it had increased the capacity in anticipation of new vistas. We do not concur with the view of Commissioner of Income Tax (Appeals) that future business demands can be predicted with accuracy by using modern business management tools. If that would be the case, no business venture would fail. The future is uncertain, market forces play a vital role in providing buoyancy to new business ventures. The claim of the assessee can be rejected if the assertions made by the assessee are found to be incorrect. The Tribunal in various cases has granted under/low capacity utilization adjustments. 9. The Bangalore Bench of the Tribunal in the case of M/s. Genisys Integrating Systems (India) Pvt. Ltd. Vs. DCIT (supra) has held as unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of capacity utilization in an elaborate manner bifurcated the issue in two parts i.e. capacity adjustment, allowable in whose hands and how to compute capacity adjustment under TNMM. The relevant extract of the order of Tribunal reads as under: 8. We have heard the rival submissions and perused the relevant material on record. Before embarking upon the question of allowability and extent of capacity adjustment under the TNMM, we want to make it clear that the assessee reduced its operating costs by considering its capacity utilization vis- -vis that of comparables and resultantly claimed that its increased profit as a result of such reduced operating costs be compared with that of the comparables. The TPO has also agreed in principle with the otherwise availability of the capacity adjustment. The issue of allowing capacity adjustment before us can be divided into two sub-issues for consideration, viz., first, whether the adjustment should be allowed in the hands of the assessee as has been done by the authorities below or comparables and second, how to compute capacity utilization adjustment under the TNMM. We will deal with these aspects one by one. i. Capacity adjustment s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trolled transaction. This refers to determining the operating profit margin of comparables with the same base as that of the assessee. Sub-clause (iii) provides that the net profit margin realized by a comparable company, determined as per sub-clause (ii) above, is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, ..... which could materially affect the amount of net profit margin in the open market. It is this adjusted net profit margin of the unrelated transactions or of the comparable companies, as determined under sub-clause (iii), which is used for the purposes of making comparison with the net profit margin realized by the assessee from its international transaction as per sub-clause (i). 9.3. Sub-rule (2) of Rule 10B provides that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to certain factors which have been enumerated therein. Rule 10B(3) states that an uncontrolled transaction shall be comparable to an international transaction, if either there are no differences between the two or a reasonably accurate adjustm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the file of the TPO/AO for giving effect to the amount of idle capacity adjustment in the operating profit of the comparables and not the assessee. ii. How to compute capacity utilization adjustment under TNMM: - 10.1. Under the TNMM, the ALP of an international transaction is determined by computing and comparing the percentage of operating profit margin realized by the assessee with that of the comparables. We have noticed above that the difference in the capacity utilizations is an important factor, which needs to be adjusted. No mechanism has been given under the Act or the rules for computing the amount of capacity utilization adjustment. 10.2. On an overall understanding, we feel that under the TNMM, the first step in granting capacity utilization adjustment is to ascertain the percentage of capacity utilization by the assessee and comparables. There can be no difficulty in working out these percentages. The second step is to give effect (positive or negative) to the difference in the percentage of capacity utilizations of the assessee vis- -vis comparables, one by one, in the operating profit of comparables by adjusting their respective operating costs. Operating co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... costs incurred by B so as to make it fully comparable. This we can do by reducing the fixed costs of B to ₹ 50 (Rs.100 into 25/50) as against the actually incurred fixed cost by it at ₹ 100. When we compute operating profit of B by substituting the fixed costs at ₹ 50 with the actually incurred at ₹ 100, it would mean that the fixed costs incurred by the assessee and B are at the same capacity utilization level. 10.3. Turning to the facts of the instant case, we find that both the TPO as well as the ld. CIT(A) have proceeded on a wrong premise not only by allowing capacity utilization adjustment in the assessee s profit, which is contrary to the legal position as discussed above, but also by considering all the comparables as one unit with the average percentage of their respective capacity utilizations. It is further observed that in the calculation of such capacity utilization adjustment, the ld. CIT(A) has considered four companies as comparable, which view has been modified by us supra inasmuch as we have held that M/s Eicher Motors and M/s. Force Motors are incomparable. Naturally, they would also go out of reckoning in the computation of idle capaci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . F I Sofex Ltd. 2005-06 2.70 53.85 2004-05 (39.19) (25.69) 2003-04 (47.58) (120.13) 2002-03 47.63 (42.02) 2001-02 (20.83) 3.74 2000-01 6.45 4.35 1999-00 48.70 29.11 13.2 The contention of the assessee is that the said companies cannot be rejected merely on the ground that in a particular year, the companies have incurred losses. We find merit in the contention of the ld. AR of the assessee. A comparable can be rejected only if it is a consistent loss making company and the consistent loss making company is one which sustains losses in the three consecutive financial years. The Pune Bench of the Tribunal in the case of M/s. Bobst India Private Limited Vs. DCIT (supra) has held as under: 5.4 Further, we find in the case of Goldman Sachs (India) Securities Pvt. Ltd. vs. AC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... phics (Noida) (P.) Ltd. reported as 354 ITR 586 concluded as under: 44. a. The mere fact that an entity makes high/extremely high profits/losses doesnot, ipso facto, lead to its exclusion from the list of comparables for the purposes of determination of ALP. In such circumstances, an enquiry under Rule 108(3) ought to be carried out, to determine as to whether the material differences between the assessee and the said entity can be eliminated. Unless such differences cannot be eliminated, the entity should be included as a comparable. 15. In the case of Cummins Turbo Technologies Limited Vs. DDIT (International Taxation) (supra) the Co-ordinate Bench of the Tribunal observed that where the assessee has taken super loss making companies in the list of comparables. The burden is on the TPO to prove that such comparable companies are consistent loss making companies. The relevant extract of the findings of Tribunal are as under: 14. We find that in respect of the selection of the comparables, the Tribunal has taken the consistent stand that as the super profit companies should not be included, the same way, super loss making companies should also be excluded. Though we agr ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
