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TMI Blog2023 (3) TMI 1138X X X X Extracts X X X X X X X X Extracts X X X X ..... to Ignition Limited, Chheda Electricals & Electronics Private Ltd. & Naina Semiconductors Ltd., unlike the assessee company, which is a start-up company. (b) In excluding the following companies, which are companies otherwise functionally comparable, from the list of comparable companies: i) Hind Rectifiers Ltd. ii) Continental Device India Private Limited iii) Incap Limited. (c) In not making working capital adjustment. (e) In disallowing reasonable adjustment for capacity utilization by the assessee company and comparable companies. (f) In Computing Operating Cost of the Assessee Company at Rs. 625,060,582 instead of actual cost of Rs. 623,698,587. (g) In incorrectly computing the operating profit margins of comparable companies. Corporate Grounds: 3. Disallowing the additions/ purchases made during the impugned year towards Building, Plant & Machinery totalling to INR 18,08,66,916/- and thus disallowing depreciation allowance u/s 32 thereon. 4. Without prejudice to the above ground, the disallowance of depreciation allowance on building and plant & machinery is computed incorrectly. 5. The impugned order passed in violation of the principles o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vable Paid/Payable Method Purchase of raw materials - 6176,88,233/- TNMM Purchase of consumables - 65,75,973/- TNMM Purchase of stock in trade - 4851,87,275/- RPM Capital assets - 366,00,912/- TNMM Technical assistance Agreement - 80,28,464/- TNMM Technical assistance Fees - 34,06,055/- TNMM Reimbursement of expenses 196,41,038/- 3,43,066/- CUP 4.2 The assessee has adopted transaction net margin method as the most appropriate method and Operating Profit by operating Oncome is considering as the profit level indicator. The margin of the assessee in the manufacturing segment is as computed below. Particulars Manufacturing Segment Revenue From Operations 56,36,73,992/- Operating Income 59,22,15,934/- Operating Expenses 62,50,60,582/- Operating profit -3,28,44,648/- GP/Sales 20.45% OP/OR -5.55% 4.3 The assessee has chosen the following comparables and accordingly concluded that the price charged is at arms length. S. No. Name of company OP/Sales 1. Hind Rectifiers -14.54 2. Ruttonsha International Rectifier Ltd. -4.91 3. Ador Powertron Ltd. -2.84 4. Continental Device India Private Ltd. 0.82 5. Incap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by stating that TNMM is robust enough to cater to variations such as capacity utilisation and that the assessee is not correct in seeking exclusion on the ground that the company has been in operation since 1971 and that cannot be compared with assessee who is in the first year of operation. 7.2 Before us, the Ld.AR submitted that Auto Ignition is a well-established company incorporated in 1971 and is in the business of manufacturing of auto electrical parts, which includes starter line motor and alternator,. The ld AR submitted that the company is manufacturing multiple products unlike assessee which is into two wheeler electrical components. It is also submitted that the company has Research & Development Dept. which have Admitted benefits derived as result of the said R & D (Pg. 2335/Vol-VI), whereas the assessee does not have any R&D activities and its attendant benefits. The ld AR brought to our attention that Auto Ignition has export earning, whereas assessee has no export earnings and operates only in the India, its primary sales being to Hero Honda. (Pg.2325/Vol-VI). The ld AR relied on the following decisions in this regard - i. Ocap Chassis Parts P. Ltd. VS. ACIT 12020 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Private Ltd. 8.1 The TPO did not accept the exclusion of this company for the reason that the assessee could not substantiate that brand value affects the profit margin. The TPO also held that the assessee has not raised any object with regard to the functional dissimilarity of the company and that the company is functionally comparable. The DRP upheld the order of the TPO by stating that the assessee is not correct in seeking exclusion on the ground that the company has been in operation for a long time which does not mean that the company has better capacity utilisation than the assessee who is in the first year of operation. 8.2 The ld AR submitted that the Chheda Electricals is a well established company and is availing benefit u/s.80IC for having manufacturing operation at Notified Industrial estate situated at Roorkee in the state of Uttarakhand. The ld AR submitted that the assessee on the other hand has newly started the manufacturing activity and does not avail any tax benefits. 8.3 The ld DR relied on the order of the lower authorities 8.4 We heard both the parties. The main grounds on which the assessee is seeking exclusion of this company are capacity utilisation a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r Modules, Axial Lead Diodes, Bridge Rectifiers and Power Stacks/ Assemblies that are used in various types of automobiles. We notice that the assessee on the other hand is in the business of manufacturing electrical components for two wheelers such as like capacitor, Discharge Igniter CDI & Regular rectifiers. We further notice that Naina is having both export as well domestic turnover whereas in assessee's case there is only domestic sales in the manufacturing segment. Naina is into R&D activities unlike the assessee. In view of all these i.e., diversified business, export sale, and incurring of expenditure on R&D activities, we are of the considered opinion that Naina cannot be considered as a comparable company. We, therefore, direct the A.O./TPO to exclude Naina from the list of comparables 10. Ground no. 2(b) is with regard to inclusion of Hind Rectifiers Ltd., Continental Device India Private Limited and Incap Limited. 11. Hind Rectifiers Ltd. 11.1 The TPO rejected on the ground of persistent losses for two years instead of three years. The DRP upheld all the exclusion of filter on the same reasons as given by TPO. The ld AR submitted that the settled position in law is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tly on similar lines as that of the assessee, though, during the year, it was in the loss could not be disqualified as nonlegitimate comparable. The Tribunal drew strength from Brigade Global services (supra) for reaching this conclusion and held that the assessee had rightly taken Capital Trust as valid comparable and the Revenue authorities have erred in excluding the same. A similar view has been taken by ITAT, Mumbai 'K' Bench in the case of Temasek Holdings Advisors vs. DCIT. In sum and substance, all the above cases is that the company making persistent loss for past 3 years is not good comparable. According to us, when loss making company has been selected for comparison in TP study for necessary, which is profit making one, there is a need for more attention qua the conditions prescribed in clause (a) to (d) of Rule 10B(2) of IT Rules, 1962 for an ultimate judgment of comparability of impugned transaction . So, the persistent loss making means continuous loss making for more than 3 years but in the case before us i.e. Stovec has earned a margin of 2.39% in comparable segment in F.Y. 2003-04. Hence, it could not be considered as loss making, so the same should be excluded fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us, in view of the fact 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." 11.4 In the given case, we notice that the comparable company has earned profits in FY 2012-13 and therefore following the ratio laid down in Affinity Express India P Ltd (supra), we hold that these companies should be included for the purpose of comparability and computation of ALP. 12. Incap Limited. 12.1 The TPO rejected the comparable on the ground that the same did not appear in search undertaken by TPO. The DRP upheld the TPO's order on the same grounds. The ld AR submitted that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us the ld AR submitted that TPO/DRP contradicted its own finding in case of Auto Ignition. Ltd where the TPO rejected the claim of the assessee despite the company having comparable functional profile only on the ground that the company was doing research & development activities and had a brand value. The ld AR further submitted that since the primary ground for rejection is that Continental Device is carrying on R&D activities then for the very same reasons, Auto Ignition & Naina Semiconductor too must be excluded as comparables. 13.3 We heard the parties. In the light of our decision with respect to exclusion of Auto Ignition & Naina in the earlier part of the order, we are of the considered view that the exclusion of Continental Device should be upheld as the company is having spends on R&D and carry intangible whereas for the assessee the year under consideration is the first year of operation. 14. Ground no. 2(c) is with regard to TPO not allowing the working capital adjustment. The DRP upheld the decision of the TPO by holding that reasonable accurate adjustment is not possible as the differences in working capital requirement itself is based on various assumptions. In thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es, 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 a 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) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 3. In Paragraph 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 these payment terms and compensate for the timing effect. 14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccepting the calculation given s 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 comparables 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. (vi) 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. (vii) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results. 16.The CIT(A) also placed reliance o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 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 page 173 & 192 of the Assessee's paper book. No defect whatsoever has been pointed out in these working by the CIT(A). We may also further add that in terms of 1ule 10B(1)( e) (iii) of the Rules, the net pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... P upheld the decision of the TPO. The Ld.AR submitted that the DRP incorrectly alleged that the assessee has not provided any documentary evidence to support of its claim. The DRP has not considered the fact that a certificate by management of the assessee company authenticating the utilized capacity 40.96%. (Pg. 725/Vol-III)was furnished in the TP proceedings along with submission dt. 25.9.2018 before TPO(Pg. 546/Vol-III)(Para 7.1.4 Pg. 13 of order) 15.2 The assessee company, being in the first year of its manufacturing operations has huge idle capacity leading to under absorption of fixed costs. This resulted in losses /reduced the profitability for the relevant assessment year. this bring needs for making capacity adjustment as the comparable companies are well established in the market and accordingly, in the different phase of growth cycle as compared to the assessee. 15.3 The range of operating profit margins of comparable companies is computed at 6.30% 7.64% and median is arrived at 6.46%. The data regarding the year of establishment of comparable companies has been reproduced in the below table which clearly validate the necessity of capacity utilization adjustment. S. N ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2) of the Rules provides comparability of an international transaction with an uncontrolled transaction needs to be judged with reference to certain specified factors. One such factor is conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 22. Rule 10B(3) of the Rules provide that: "An uncontrolled transaction shall be comparable to an international transaction if -- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences." 23. As per Section 92C of the Act, ALP is required to be computed using any of the given six methods and in the manner as is prescribed in Rule 10 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In order to be considered comparable to a controlled transaction, an uncontrolled transaction need not be identical to the controlled transaction, but must be sufficiently similar that it provides a reliable measure of an arm's length result. If there are material differences between the controlled and uncontrolled transactions, adjustments must be made if the effect of such differences on prices or profits can be ascertained with sufficient accuracy to improve the reliability of the results. For purposes of this section, a material difference is one that would materially affect the measure of an arm's length result under the method being applied." 26. The Indian transfer pricing regulations, OECD Guidelines and the US transfer pricing regulations call for an adjustment to be made in case of material differences in the transactions or the enterprises being compared so as to arrive at a more reliable arm's length price/ margin. While the Indian transfer pricing regulations refer to the adjustments on uncontrolled transactions, however the same has to be read with Rule10B(3) of the Rules which clearly emphasizes the necessity and compulsion of undertaking adjustments. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment for capacity underutilization can be granted" (iv) In the recent case of GE Intelligent Platform Private Limited (IT(TP)A No. 148/Bang/2015 and 164/Bang/2015) for AY 2010-11 was held as follows: "8 now the law is quite settled to the extent that once there is unutilized capacity or men power, such underutilization impacts margin and therefore, the adjustment should be made while computing the ALP If the underutilization is more than average underutilization of the industry then necessary adjustment is required to be made to the margin of computing ALP" 27. Moreover, the above argument of the assessee for grant of capacity utilization adjustment is also supported by the following decision of Bangalore ITAT in the case of Genisys Integrating Systems (India) Pvt. Ltd (ITA No.1231/Bang/2010). Relevant extract of the decision is under:- "15.2 We agree with this contention of the counsel for the assessee. All the comparables have to be compared on similar standards and the assessee cannot be put in a disadvantageous position, when in the case of other companies adjustments for under utilization of man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is accordingly factually and legally eligible to an adjustment for the same. Therefore, such a benefit cannot be denied to the assessee only for the reason that the data about comparable companies is not available. Requiring the assessee to produce such a data which is not available in public domain would tantamount to requiring the Appellant to perform an impossible task. The only way to get the data in the current case, would be where the TPO collates the same from the comparable companies by exercising his powers under section 133(6) of the Act. The relevant extracts of the section are as under:- "(6) require any person, including a banking company or any officer thereof, to furnish information in relation to such points or matters, or to furnish statements of accounts and affairs verified in the manner specified by the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals), giving information in relation to such points or matters as, in the opinion of the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals), will be useful for, or relevant to, any enquiry or proceeding u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this regard, the Ld.AR submitted that during the TP proceedings, the TPO has considered the operating expenses at Rs.62,50,60,582/- instead of Rs.62,36,98,587/-. Due to this, the operating profit margin of the assessee has been incorrectly taken ar (-)5.50% whereas the correct margin is at (-)5.32%. The Ld.AR submitted that the DRP gave a direction to the TPO to verify and consider the correct operating expenses. The TPO in the OGE has retained the same operating expenses for the reason that the assessee did not furnish the required details. The Ld.AR therefore prayed for a direction in this regard to the TPO. 16.2 The Ld.DR submitted that the TPO has not considered the cost for the reason that the assessee has not furnished the required details and therefore the Ld.DR supported the order of the TPO. 16.3 We heard the parties and perused the material on record. In the interest of justice to give one more opportunity to the assessee, we remit the issue to the TPO to verify and allow the correct operating expenses for the purpose of computing the operating margin of the assessee. 16.4 The TPO is directed to compute the ALP in accordance with the directions given in this order. 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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