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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 ..... 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. Hind Rectifiers Ltd. - 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 ( 2016 (3) TMI 1121 - ITAT PUNE] we hold that these companies should be included for the purpose of comparability and computation of ALP. Incap Limited - TPO rejected the comparable on the ground that the same did not appear in search undertaken by TPO - We are of the view that identical directions as per PRISM NETWORKS PRIVATE LIMITED case [ 2022 (2) TMI 1296 - ITAT BANGALORE] it would be just and sufficient in the present case hence the regarding inclusion of the aforesaid company as comparable company is hereby set aside to AO/TPO for fresh consideration. Continental Device India Private Limited - 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 wher ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tax Act (the Act) dated 17.10.2019 for A.Y. 2015-16. 2. The assessee raised the following grounds of appeal: The grounds stated here below are independent of, and without prejudice to one another: 1. On the facts and in the circumstances of the case, the Ld. TPO/DRP has grossly erred in making adjustment of Rs. 7,05,68,803 to the international transaction pertaining to manufacturing segment i.e. purchase of raw material and consumables u/s 92CA of the Act. The Ld. TPO/AO erred on facts and in law:- 2. (a) Selecting well established companies like Auto 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iz., M/s. Comstar Automotive Technologies Pvt. Ltd. from the final list of comparables and accordingly, the TP adjustment was reduced to Rs.7,05,68,803/-. With respect to depreciation, based on various evidences submitted by the assessee, the DRP directed the AO to recompute the disallowance due to which the disallowance of depreciation was enhanced to Rs.10,51,78,519/-. The assessee is in appeal before the Tribunal against the final order of assessment passed pursuant to the directions of the DRP. 4. TP adjustment: 4.1 During the year, the assessee had the following international transactions. Particulars Received/Receivable 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 Te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6.30 4 Ruttonsha International Rectifier Ltd. 6.46 5 India Nippon Electricals Ltd. 7.64 6 Naina Semiconductors Ltd. 9.11 7 Comstar Automotive Technologies Pvt. Ltd. 12.57 35th Percentile 6.30 Median 6.46 65th Percentile 7.64 4.5 Therefore the TPO arrived at the TP adjustment in the manufacturing segment as below. Manufacturing Segment Particulars Formula Amount (INR) Taxpayer's operating revenue OR 59,22,15,934/- Taxpayer's operating cost OC 62,50,60,582/- Taxpayer's operating profit OP -3,28,44,648/- Taxpayer's PLI ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ponents. 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 120201 113 Taxmann.com 278 (Del. Trib) ii. Brintons Carpets Asia (P.) Ltd. v Deputy CIT Circle 1(1), Pune [2011] 12 taxmann.com 148 (Pune) iii. CIT, Pune v. Keihin Fie (P.) Ltd. [2018] 93 taxmann.com 75 (Bombay) iv. Keihin FLE (P.) Ltd. v. Asst. CIT Circle-9, Pune [2015] 57 taxmann.com 287 (Pune - Trib.)(Only Head note) v. Alfa Laval (I) Ltd. v. Dy CIT, Pune. [2014] 46 taxmann.com 394 (Pune -Trib.) 7.3 It is further submitted that Auto Ignition has Intangible assets and the assessee has no intangible assets. Auto Ignition manufactures multiple items and has a long established business in diverse geographies a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rst 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 and Chheda claiming tax deduction u/s.80IC. The adjustment towards capacity utilisation has been contended as a separate issue by the assessee and hence the exclusion of this cannot be sought on this ground. Further the company enjoying the tax deduction u/s.80IC in our view is not a criteria for seeking exclusion. Further we notice that Chedda is functionally similar to the assessee. We, therefore, uphold inclusion of Chheda Electricals in the list of comparables. 9. Naina Semiconductors Ltd. 9.1 The TPO did not accept the exclusion of this company for the reason that the assessee could not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness, 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 that where a company has earned profit in any year out of three years, it cannot be termed as persistent loss making company, hence cannot be excluded as comparable. Hind Rectifiers has earned profit in F.Y. 2012-13 as per the below calculation sheet filed before TPO, which the TPO or DRP have not questioned (Pg. 552- /Vo1411). Financial Year Profit/(Loss) before tax (in RS. Crores) Paper Book Ref. F.Y. 2014-15 -5.91 1906/Vol-V ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enue 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 for computing operative margin of comparable companies for arriving at ALP in relation to international transactions pertaining to EOU operations. The Assessing Officer is directed accordingly. 14. The contention of the Revenue is that results of the aforesaid two comparable entities are on the extreme negative side. Ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the company is functionally comparable since the same is engaged in business of manufacturing both AC and DC volts Aluminium Electrolytic ol-Capacitors. (Pg. 2053/Vol-VI). The ld AR submitted that since the TPO has not looked into the financials of the company and has rejected on the ground that it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 this regard, the Ld.AR submitted that the detailed calculation of adjusted operating profit margin of comparable companies selected by TPO was provided during the assessment proceedings. The Ld.AR further submitted that it is a settled law that working capital adjustment has to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 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 from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 on a decision of Chennai ITAT in the case of Mobis India ITA No.2112/Mds/2011 (2013) 38 taxmann.com. That decision was based on the factual aspect that the Assessee was not able t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, between the international transaction and the comparab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t 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. No. Company Name Operating Margins of A.Y. 2015-16 Date of Incorporation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat adjustments should be made to account for: ...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 23. Rule 10B(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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ional net margin method' (Emphasis supplied) 25. US transfer pricing Regulations on this aspect is as follows:- In addition, the US transfer pricing regulations, u/s 482 of the Internal Revenue Code (hereinafter referred to as 'the US regulations') also support the above. Regulation 1.482-1(d)(2) of the US regulation states as follows: 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... justment for under-utilization of capacity is allowable in the case on hand and if so, the manner of computation thereof and the quantum of adjustment 10.4.5 In the above cited case of the Mumbai Tribunal i.e. Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity under-utilization can be granted Following the decision of the ITAT, Mumbai 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilization adjustment. 31. The assessee has under-utilized capacity during the subject AY and 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 af ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the manufacturing segment (page 725 paper book volume III). Considering the details furnished and respectfully following the above decision of the coordinate bench we remit the issue back to the AO/TPO with similar directions. Needless to say that the assessee be given a reasonable opportunity of being heard. It is ordered accordingly. 16. Ground no. 2(f) is with regard to TPO considering the incorrect operating cost. 16.1 In 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e additions and assessee is not right in requesting for one more opportunity. 18.4 We heard the parties and perused the material on record. We notice that the assessee has submitted various details in support of the additions made to building and plant machinery. We also notice that the AO in the remand proceedings has enhanced the disallowance for the reason that invoices were not enclosed for some of the additions and also purchase vouchers were not enclosed for certain other additions. We also notice that the assessee has submitted the full details pertaining to the additions before the lower authorities (Pgs. 136-144 of Vol 4 Paper book). Given these facts, in the interest of justice, we are of the considered view that the assessee should be given one more opportunity to substantiate the claim. Accordingly, we remit the issue back to the AO with the direction to consider the various invoices / purchase vouchers submitted by the assessee. The assessee is directed to provide all the relevant details and the reconciliation to substantiate each of the additions made to building and plant and machinery and cooperate with the proceedings. It is ordered accordingly. 19. Ground ..... X X X X Extracts X X X X X X X X Extracts X X X X
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