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TMI Blog2022 (5) TMI 34X X X X Extracts X X X X X X X X Extracts X X X X ..... ards AE transactions (Ground 9) [This addition was unilaterally added by the DRP] 3. Brief facts of the case are as follows: The assessee is a subsidiary of the Tokai Rika Company Ltd., based in Japan. The assessee is mainly engaged in manufacturing key sets and locks to automotive industry. The assessee has manufacturing facility. The assessee in its TP study, has adopted TNMM as the most appropriate method. The assessee has arrived at set of 2 comparable companies with an average OPM of 2.80% viz-a-viz that of 23.11 % of the assessee. The assessee made various adjustments to arrive at the OPM. Thus, in the TP study, it was concluded that international transactions are at arm's length. 4. The TPO rejected the comparables set taken by the assessee. The TPO conducted a fresh TP analysis and selected a set of 6 comparable companies and arrived at OPM of comparables at 4.37%. After rejecting the adjustments made by the assessee, the TPO arrived at OPM of the assessee at -10.82%. The TPO therefore proposed a TP adjustment of Rs. 4,69,48,996. 5. Aggrieved by the above TP adjustment, the assessee filed objections before the DRP. The DRP rejected the objections of the assessee. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case of Huawei Technologies India Private Limited reported in 101 taxmann.com 313. * The Assessee has also argued that the TP adjustment should be restricted only to the international transactions. The Assessee submitted that the DRP has erred in computing the transfer pricing adjustment for the total operating costs. The Ld. Counsel for the Assessee submitted that the transaction with non-AE cannot be subject matter of determination of ALP because section 92 clearly speaks of determination of ALP only in respect of transactions with AE. The Assessee relied on the decision in the case of IKA India P. Ltd. 101 taxmann.com 276. 7. The learned Departmental Representative has filed a brief submission supporting the orders of the TPO and the DRP. 8. We have heard the rival submissions and perused the material on record. The assessee has submitted that the TPO has done fresh/TP analysis but did not furnish the search process and the accept/reject matrix, while selecting fresh set of comparables. The assessee has also submitted that the DRP has not considered the detailed submissions made by the assessee on various issues. We observe that the TPO has given the search process in p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m's length of the international transaction. On perusal of the TPO's order and the DRP's order, confirming the same, it is clear that the directions of the Tribunal in its earlier order has not been given effect to. The TPO has admitted that depreciation cost of the comparable companies is lesser than the assessee (since deprecation policy followed by comparable companies is as per Companies Act, whereas the assessee was showing higher rate of depreciation based on some agreement (see page 5 of the TPO's order). Hence, suitable depreciation adjustment ought to have been made by AO/TPO. Therefore, this issue is restored to the files of the AO/TPO. The AO/TPO is directed to allow depreciation adjustment if they notice the rate of depreciation are different in the case of the assessee and the comparable cases. Therefore, ground 4 is allowed for statistical purposes." 11. However, we observe that there is no analysis with respect to depreciation policy of the assessee and comparable cases. Therefore, we are of the view that let this matter be re-examined by the TPO/AO afresh. The assessee should demonstrate whether there is any difference in depreciation policy of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... factors to be taken into account herein is the ability to make reliable and accurate adjustments. 24. The OECD Guidelines on this aspect is as follows:- Para 1.35 of the OECD Guidelines states as follows: "Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm's length conditions" Para 1.36 of the OECD Guidelines states as follows: ".... material differences between the compared transactions or enterprises should be taken into account. In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm's length conditions (or a range thereof), it is necessary to compare attributes of the transactions or enterprises that would affect conditions in arm's length dealings. Attributes that may be important include the characteristics of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contract ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in harmony, the adjustments should be made on the tested party. In the following decisions it has been held that adjustment to the profit margins have to be made on account of underutilization of capacity: (i) In the case of M/s. Mando India Steering Systems Private Limited vs. Assistant Commissioner of Income Tax, [I.T.A. No. 2092/Mds 12012], the Tribunal upheld the contention of the taxpayer for making a suitable adjustment on account of idle capacity for the purpose of margin computation. The relevant extract is reproduced as below: "10. .......... We are of the considered view that underutilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production." (ii) In the ruling of DCIT Vs. Panasonic AVC Networks India Co Ltd. (I.T.A. No.: 4620/Del/2011), it was held that:- "5. ..... Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of its infrastructure. The AO shall consider this fact also while determining the ALP and make the TP adjustments. With these directions, the appeal of the assessee is disposed of." 28. The reliability and accuracy of adjustments would largely depend on availability of reliable and accurate data. For certain types of adjustments, relevant data for comparables may either not be available in public domain or may not be reliably determinable based on information available in public domain, whereas, it may be possible to make equally reliable and accurate adjustments on the tested party (whose data would generally be easily accessible). 29. In such a scenario, one has to resort to the provisions of Rule 10B(3)(ii) which provides for making "reasonably accurate adjustments" for eliminating any material differences between the two transactions being compared. The purpose or intent of the comparability analysis is to examine as to whether or not, the values stated for the international transactions are at ALP i.e., whether the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don't restrict or provide that the adj ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iara Jewellery P. Ltd. (I.T.A. No. 8109/Mum/2011), has directed the AO/TPO to obtain the exact details of capacity utilization of comparable companies, if not available in public domain. The relevant extract of the aforesaid decision is as under:- "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 assessee an opportunity of being heard." (Emphasis Supplied) 33. Accordingly, we direct the TPO to exercise powers under section 133(6) of the Act to call for information on capacity utilization of the comparable companies such as-- * Installed Capacity, * Actual Production in Units, * Break-up of Fixed Cost and V ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 [or the specified domestic 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-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction); (f) ** ** ** (2) For the purposes of sub-rule (1), the comparability of an international transaction [or specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called "comparability adjustments. 13. In Paragraphs 13 to 16 of the aforesaid OECD guidelines, need for working capital adjustment has been explained as follows: "13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect thes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ving that the purpose of working capital adjustments is to improve the reliability of the comparables. 15. In the present case the TPO allowed working capital adjustment accepting the calculation given by the Assessee. The CIT(A) in exercise of his powers of enhancement held that no adjustment should be made to the profit margins on account of working capital differences between the tested party and the comparable companies for the following reasons: (i) The daily working capital levels of the tested party and the com parables was the only reliable basis of determining adjustment to be made on account of working capital because that would be on the basis of working capital deployed throughout the year. (ii) Segmental working capital is not disclosed in the annual reports of companies engaged in different segments and therefore proper comparison cannot be made. (iii) Disclose in the balance sheet does not contain break up of trade and non-trade debtors and creditors and therefore working capital adjustment done without such break up would result in computation being skewed. (iv) Cost of capital would be different for different companies and therefore working capital adjust ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction on working adjustment based on unavailable daily working capital requirements data. There is also no merit in the objection of the CIT(A) regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines clearly advocates adopting rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. Therefore this objection of the CIT(A) is also not sustainable. 17. In the light of the above discussion we are of the view that the CIT(A) was not justified in denying adjustment on account of working capital adjustment. Since, the CIT(A) has not found any error in the TPO's working of working capital adjustment, the working capital adjustment as worked out by the TPO has to be allowed. We may also add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at pages 173 & 192 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... international transactions i.e., transactions with AE. The ITAT in the case of Continental Automotive Components India Private Limited IT(TP)A No. 713/Bang/2017 has held as follows: "53. We have considered the rival submissions. This issue was considered by the Hon'ble Supreme Court in the case of CITv. Hindustan Unilever Ltd., 99 taxman.com 134 (SC) wherein it was held that while determining the ALP of international transactions, benchmarking has to be done only on Associated Enterprises transactions and not for the entire turnover. In view of this, we-find force in the argument of the Ld. AR that the TP adjustment should be restricted only to international transactions pertaining to purchase of raw materials from AEs and other related transactions only. With these observations, we allow this ground of the assessee." 17. In view of the transfer pricing provisions and various judicial precedents, we hold that the transfer pricing adjustment should be restricted only to the AE related transactions of the assessee. 18. Therefore, we set aside the orders of the TPO and DRP and direct the TPO to redetermine the TP adjustment afresh. The TPO while determining the TP adjustment s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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