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TMI Blog2022 (3) TMI 1528X X X X Extracts X X X X X X X X Extracts X X X X ..... of allocation in case in support of segmental drawn by it. The AO / TPO shall give proper opportunity of hearing to the assessee. Capacity adjustment - We find that the settled law is that adjustment on account of capacity utilization has to be granted. The additional evidence now produced go to the root of the issue of determination of ALP on the manufacturing segment. For a proper adjudication of the issue and for substantial cause, the same is admitted and taken on record. Accordingly, we set aside the issue to the file of the AO / TPO, directing to follow the directions given in the case of IKA India Private Limited [ 2018 (10) TMI 49 - ITAT BANGALORE ] Foreign exchange fluctuations adjustment - TPO and the DRP have not properly analysed the submissions of the assessee. There is no analysis whether there was any adverse foreign exchange fluctuations during the relevant assessment year, which is abnormal in nature and what is its effect on the operating margin of the assessee and the comparables. These aspects needs to be analysed - it would be just and appropriate to set aside the impugned order on this issue and remand the issue to the TPO. Impairment of loss - We observe from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for fresh determination. TP Adjustment of ITES Segment - comparable selection - HELD THAT:- Exclusion of companies as functionally dissimilar with that of assessee ITES segment. Working Capital Adjustment - ITES segment - HELD THAT:- Respectfully following the decision of Huawei Technologies India (P.) Ltd. [ 2018 (10) TMI 1796 - ITAT BANGALORE ] we also hold that the working capital adjustment is to be allowed as per actuals, after considering the decisions rendered in this order on the exclusion/inclusion of comparable companies out of/into the final set of comparables. The TPO/ AO are accordingly directed. After proposing the TP adjustment on account of management fees, the DRP suo moto proposed disallowance of the same management fees u/s 37 - assessee has not furnished the details of the expenses - HELD THAT:- We are of the view that the protective disallowance of management fees u/s 37 of the I.T. Act needs to be considered afresh since the issue of transfer pricing adjustment of management fees has already been remitted back to the AO/TPO for fresh examination. X X X X Extracts X X X X X X X X Extracts X X X X ..... n tapes, die-cut products etc. The segmental details of the manufacturing and other segment as per the TP documentations, have been extracted at para 3.1 of the TP order. The TPO has recomputed the segment details for the three segments, which is at para 3.2 of the TP order. The essential difference between the segmental details as computed by the assessee (para 3.1 of the TP order) and as recomputed by the TPO (para 3.2 of the TP order) are as under:- (i) The assessee has made adjustment for capacity utilization (capacity taken as 60%), whereas the TPO has disregarded the adjusted capacity utilization and considered the full amounts. (ii) The assessee had taken adjustment for Forex fluctuation (1,91,82,480) whereas the TPO has not considered the adjustment. (iii) The TPO has added an amount of Rs.97,19,858 towards exchange loss, which means he had considered this amount as not part of operating expenses. (iv) The TPO has added an amount of Rs.1,73,89,263 towards impairment loss, which means he had considered this amount as not part of operating expenses. (v) The TPO has taken the segmental apportionment as 56.35%, 8.29%, and 35.36%. 4.2 The assessee in manufacturing seg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the capacity was underutilized due to slumping the market and subsequent closure of Nokia business. The TPO has not allowed capacity utilization adjustment on the ground that adjustment has to be computed on the tested party and not on the comparables. The assessee relied on the order of ITAT in the case of IKA India Private Limited (supra) and submitted additional evidence providing computation of capacity utilization adjustment as outlined in the Tribunal decisions. (iii) The learned AR submitted that due to adverse foreign exchange fluctuations, import cost of raw materials from Bradley group companies and third parties have increased considerably. The assessee has submitted that increase in import cost could not be passed on to the end customer due to competitive environment in the industry. The assessee has therefore claimed economic adjustment towards Forex fluctuations. The assessee has relied on the order of the ITAT in the case of Honda Trading Corporation India Private Limited in ITA No.5297/Del/2011 (order dated 08th March, 2013). (iv) On the issue of adjustment for impairment of loss, the learned AR submitted that the Brady Group sold the DC and HPI products ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a Private Limited (supra) has held as follows [Bangalore Bench followed its earlier order in IKA India Private Limited's case for assessment year 2012-2013 in IT(TP)A No.2192/Bang/2017 (order dated 17.09.2018)]. The relevant finding of the Tribunal in case of IKA India Private Limited for assessment year 2012-2013 reads as follows:- "22. We have heard the submissions of the assessee and the ld. DR on the issue raised by the assessee in ground No.7. We shall first see the statutory provisions relevant to the issue. Rule 10B(1)(e) of the Rules states that 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quot; Further, Para 2.74 of the OECD Guidelines while laying down the comparability criteria to be adopted while applying the transaction net margin method states as follows: "….. Thus where the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method' (Emphasis supplied) 27. 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 m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment." (iii) In the case of Biesse Manufacturing Company Limited (IT(TP) A Nos. 97 & 493/Bang/2015) for AY 2010-11, the Tribunal held as follows: "10.4.1. We have heard the rival contentions and perused and carefully considered the submissions made and material on record; including the judicial pronouncements cited. The issue for consideration is whether adjustment for under-utilisation 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-utilisation 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 under-ut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction of similar nature. The regulations don't restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/transactions as per subclause (i) of rule 10B(1)(e) of the Rules itself. The absence of specific provision in Rule 10B(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been upheld in the following decisions:- • Capegemini India Pvt. Ltd. (ITA No.7861/Mum/2011) • Demang Cranes & Components (India) Pvt Ltd. [49 SOT 610 (Pune)] 32. As far as data of comparable companies 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. 33. The assessee has under-utilized capacity during the subj ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable companies such as -- • Installed Capacity, • Actual Production in Units, • Break-up of Fixed Cost and Variable Cost; • Segmental/ product wise information, if any. 36. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No.7 is decided accordingly." 4.6.2 The assessee has also produced as additional evidence, computation of capital utilization adjustment as stated in the above judicial pronouncements. The additional evidence now produced go to the root of the issue of determination of ALP on the manufacturing segment. For a proper adjudication of the issue and for substantial cause, the same is admitted and taken on record. Accordingly, we set aside the issue to the file of the AO / TPO, directing to follow the directions given in the case of IKA India Private Limited (supra). 4.6.3 On the issue of foreign exchange fluctuations adjustment, we observe that the TPO and the DRP have not properly analysed the submissions of the assessee. There is no analysis whether there was any adverse foreign e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Singapore 5% 8.54% Brady Worldwide Inc (BWW) BWW At cost 9.06% 5.1 The TPO had apparently accepted the ALP of the management fee transaction, as no adjustment was proposed by him in the TP order. However, the DRP suo moto decided that the ALP of this transaction as Nil and directed the AO / TPO to add the entire amount as adjustment. 5.2 Aggrieved, the assessee has raised this issue before the ITAT. It was submitted that the DRP was wrong, both on facts and on legal principles. The submissions of the learned AR in brief are summarized as follows:- (i) No opportunity provided to assessee by DRP. The assessee submits that the TPO had issued a show cause notice in connection with management fees, to which the assessee had responded with its detailed submission and supporting evidences. The TPO did not propose any adjustment (SCN at page 702 of PB). During the course of the DRP hearing, the Panel members had not discussed this issue with the assessee nor requested us to furnish any information / documents. Subsequently the DRP had suo moto determined the ALP of this transaction as Nil in the DRP directions. By doing so, the Panel has passed the directions without giving ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ive. In these given facts and circumstances of the case, we deem it fit and proper that the issue of determination of ALP of the management fees be remanded to the AO / TPO for fresh determination. The AO / TPO shall afford the assessee reasonable opportunity of being heard before a decision is taken in this matter. It is ordered accordingly. 5.5 In the result, grounds 14 to 22 are allowed for statistical purposes. ITES Segment (Grounds 23 to 34) (TP adjustment) 6. Brief facts in relation to ITES segment are as follows: It is stated that the assessee has maintained full segmental details of the three segments, namely, manufacturing segment, trading segment and service segment. The segmental details of ITES segment is at para 3.1 of the TP order. However, the TPO disregarded the segmental details and revised the same as given in para 3.2 of the TP order. The assessee selected a set of 11 comparable companies, as given in para 11 of the TP order. However, the TPO rejected the TP documentation of the assessee and conducted his own TP analysis by adopting his own filters. The TPO selected a set of six comparables. The set of comparables selected by the TPO (at page 27 of the TP or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ollows:- "7.4.1 We have considered the rival contentions / submissions and perused the material on record; including the judicial decisions cited. We find from a perusal of the Annual Report at page 14 thereof, under the head 'Managements Discussion and Analysis', it has been stated that this company provides services to both horizontal and vertical focus areas. The Horizontal focus areas are sourcing and procurement (S & P), Customer Services (CS), Finance and Accounting (F & A), Legal Process Outsourcing (LPO), Sales and Fulfillment (S & F), Analytics (AT), Business Platform (BP), Business Transformation Services (BTS), Human Resources Outsourcing (HRO) and Technology Solution Optimization (TSO). The Vertical focus areas of services are Financial Services & Insurance (FSI) Manufacturing (MFG), Energy, Utilities Communication & Services (ECS) and Retail, Consumer Packaged Foods, Logistics & Life Services (RCL). From the above, it is clear that 'Infosys' offers a gamut of different and diversified services which cannot be compared with routine back office services provided by the assessee. In fact, it is mentioned at page 14 of the Annual Report that the company 'Infosys' provide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ils service income filter applied by the TPO (ITes income of only 5.68%) (c) Significant R&D activities. (d) Extraordinary growth during the year (growth of 43%) (e) Higher scale of operations. 7.3 We have heard rival submissions and perused the material on record. The Bangalore Bench of the Tribunal in the case of M/s.Ocwen Financial Solutions Private Limited (supra), had excluded M/s.Microland Limited from the list of comparable company. The relevant finding of the Bangalore Bench of the Tribunal, reads as follows:- "8.4.1 We have considered the rival contentions / submissions put forth and perused the material on record. This company, 'Microland' was selected as a comparable by the TPO. In his order, the TPO has stated that this company 'Microland' is currently organized in business segments, comprising of infrastructure management services and IT Enabled Services (ITES). On the objections raised by the assessee that 'Microland' is not functionally comparable, the TPO rejected the same by holding that both its segments are in the nature of ITES only, considered its entire operations as ITES and held the company to be comparable to the assessee at entity level. In respec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is seen that out of the total revenue of Rs.34,471 lakhs, the revenue from ITES segment is Rs.1959 lakhs; which is 5.68% of the total revenue. As we have concluded that the infrastructure services segment is a different business segment not comparable to ITES rendered; this company, 'Microland' fails the filter adopted by the TPO that companies whose service income is less than 75% of total operating revenue are to be excluded. In view of the facts and circumstances of the case, as discussed above, and in view of the above factual findings, we hold that Microland Ltd., should be excluded from the final set of comparables in the case on hand." 7.1.1 In the light of the order of the co-ordinate Bench of the Tribunal, we hold that the AO/TPO is not justified in including the above company in the list of comparable companies. Accordingly, we direct the AO/TPO to exclude the Microland Limited from the list of comparables. 7.1.2 In the result, ground 23 is partly allowed. Inclusion of comparable companies, viz., (i) Informed Technologies Limited, (ii) Crystal Voxx Limited, (iii) Jindal Intellicon Limited (Ground 24) The AO/TPO has excluded the above companies from the list of co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of comparables. We hold and direct the AO/TPO accordingly." 8.3.1 In the light of the order of the co-ordinate Bench of the Tribunal, we hold that the AO/TPO is not justified in excluding the above company from the list of comparable companies. Accordingly, we direct the AO/TPO to include Informed Technologies Limited in the list of comparables. (ii) Crystal Voxx Limited ('Crystal') 9.1 The assessee has objected to the exclusion of this company Crystal Voxx Limited for the following reasons:- (a) The TPO has wrongly stated that the company does not report export earnings. (b) The company has earned 97.33% of income from export of services. 9.2 The learned AR relied on the order of the ITAT in the case of M/s.Ocwen Financial Solutions Private Limited (supra). 9.3 We have heard rival submissions and perused the material on record. The Bangalore Bench of the Tribunal in the case of M/s.Ocwen Financial Solutions Private Limited (supra), had included Cyrstal Voxx Limited in the list of comparable company. The relevant finding of the Bangalore Bench of the Tribunal, reads as follows:- "11.4 We have considered the rival contentions / submissions and perused the mater ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the company is engaged in providing call centre services, both in the overseas and domestic market; export of call centre services forming a major part of its business activities. In these circumstances, the observation of the DRP that this company 'Jindal' is engaged in software development services and ITES and segmental information is not available is not a factually correct observation; as borne out from the Annual Report of this company. Further, at page 160 of the Annual Report (i.e., page 657 of the paper book), it is seen that the segmental data of domestic and international segments of operation are given; thereby rendering the observations of the TPO is factually incorrect. 12.4.2 As far as the functional comparability of this company, 'Jindal' is concerned, we find that the Co-ordinate Bench of this Tribunal, in the case of CGI Information Systems and Management Consultants Pvt. Ltd., (supra) for Assessment Year 2012-13 has held that this company should be included in the set of comparables for companies rendering ITES and in this regard at para 56 thereof has held as under:- 12.4.3 In respect of the assessee in the case on hand also, the facts are similar to the cite ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sions. The relevant provisions of the Act insofar as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows; Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a)**** (e) transactional net margin method, by which - (i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transaction is computed having regard to the same base: (iii) the net profit margin referred to in sub-cla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rule 10B(1)(e)(iii) of the Rules read with Sec. 92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be 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. 12. Chapters I and III of the DECO Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the "TPG") contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the DECO on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm's length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ey (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers - (less) the period granted to pay debts in suppliers" 14. Examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to he kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures, (ii) the selection of the appropriate interest rare (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The guidelines conclude by observing that the purpose of working capital adjustments is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... venue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing working capital adjustment, the Delhi Bench of ITAT in the case of ITO v E Value Servc.com [2016] 75 taxmann.com 195 (Delhi -Trib.}, has held that insisting on daily balances of working capital requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opening and closing working capital deployed. The Bench has also observed that in Transfer Pricing Analysis there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. Therefore there is little merit in CIT(A)'s objection on working adjustment based on unavailable daily w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nto such transactions are likely to materially affect the price or cost charged to 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." 18. In such a scenario there would remain no comparable uncontrolled transactions for the purpose of comparison. The transfer pricing exercise would therefore fail. Therefore in keeping with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison. Therefore the working capital adjustment as claimed by the Assessee should be allowed. We hold and direct accordingly. 11.2 Respectfully following the above decision of the Coordinate Bench in the case of Huawei Technologies India (P.) Ltd. (supra), we also hold that the working capital adjustment is to be allowed as per actuals, after considering the decisions rendered in this order on the exclusion/inclusion of comparable companies out of/into the final set of comparables. The TPO/ AO are accordingly directed. 11.3 In the result, ground 26 is allowed for statistical purposes. Management fees (Ground 35 t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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