HITACHI ASTEMO CHENNAI PVT. LTD.,CHENGALPATTU vs. ITO, CORP. WARD-2(3), CHENNAI

आदेश / O R D E R PER MANU KUMAR GIRI, JM:

These two appeals are filed by the Assessee against the order passed by the Commissioner of Income-tax (Appeals) [CIT(A)], both dated 27.12.2024, for the Assessment Years (AYs) 2017-18 and 2018-19 respectively, in respect of Transfer Pricing (TP) adjustments arising from international transactions of purchase of raw materials from Associated Enterprises (AEs).

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The issue in both appeals being identical, these were heard together and are disposed of by way of this common order. AY 2017-18 is taken as the lead year. 2. The assessee has raised the following grounds of appeal in IT(TP)A 5/Chny/2025: I. GENERAL GROUNDS 1. The lower authorities' erred in finalizing an order of assessment which suffers from legal defects such as being passed in violation of principles of natural justice, contrary to the provisions of the Income Tax Act, 1961 ("the Act"), is devoid of merits, contrary to facts on record and the applicable law, and was passed without adequate inquiries, therefore is liable to be quashed. II. TRANSFER PRICING (TP) MARGIN ADJUSTMENT 2. The Lower Authorities erred in finalizing a TP adjustment of INR 8.57 Crores under section 92CA(3) of the Act, in determining the arms' length price of the Appellant's international transactions related to its manufacturing activities. 3. The lower authorities erred in rejecting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Rules, and in adopting arbitrary procedures to finalize the adjustment, such as but not limited to the application of filters, functional and economic analysis, selection of comparable companies, non-furnishing of details of the fresh search process undertaken by the Ld. TPO, not following the due conditions in section 92C(3) of the Act, margin computation, amongst others.

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Margin and economic adjustments 4. The Lower Authorities erred in re-computing the Appellant's operating margin earned from its business of manufacture and sale of engine components in the Indian market. 5. The Lower Authorities erred in rejecting the Appellant's claim for an economic adjustment to account for differences in capacity utilization of the Appellant vis-à-vis the comparable companies, in determining the arms' length nature of its transactions under the Transactional Net Margin Method ("TNMM"), without appreciating that Impugned AY was the Appellant's initial full-year of operations. 6. The lower authorities erred in not exercising the powers under section 133(6) of the Act, to call for the capacity utilization details from the comparable companies and in arbitrarily 7. The lower Authorities erred in considering additional companies for the benchmarking analysis, which are not comparable to Appellant on account of, inter alia, functional dissimilarity, non-satisfaction of the quantitative and qualitative criteria, pursuant to a fresh search. 8. Without prejudice to the above, the lower authorities erred in not providing the detailed search process adopted, keywords used for selection of comparable companies and the filters adopted, thereby prejudicing the Appellant's ability to validate the search process adopted by the Ld. ΤΡΟ. 9. Without prejudice, the lower authorities erred in disregarding the supplementary benchmarking submitted by the Appellant, wherein a transaction-wise approach of benchmarking the international transactions related to the manufacturing activity was adopted. Page 3 of 15

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Further, the submissions during the hearing were restricted to grounds raised against the rejection of the Assessee’s claim for an economic adjustment to account for differences in its capacity utilization vis-à-vis the Comparable Companies (Ground of Appeal No. 2, 5 and 6 for AY 2017-18, and Ground of Appeal No.II - 1, 5 and 6 for AY 2018-19), as summarized hereinbelow. A. Capacity-Adjustment undertaken by the Appellant in its TP study is valid and permissible under the law The Assessee is a ‘licensed manufacturer bearing normal risks’ operating in the automotive industry, and AY 2017-18 was the first full year of its operations. It adopted the Transactional Net Margin Method (‘TNMM') under Section 92C of the Act as the most appropriate method, considering itself as the ‘tested party’ with (Operating Profit/ Operating Income) (“OP/OI”) as the profit level indicator (“PLI”). The impugned years, being the first and second full years of operations, i.e., the initial/start-up phase of business, the Assessee had utilized only 20.31% & 35.39% of its production capacity in AY 2017-18 and AY 2018- 19 respectively. Therefore, around 80% and 65% of the Assessee’s capacity was idle and under-utilized, resulting in higher fixed cost absorption per unit and lower profits. The said capacity utilisation was determined as the proportion of the actual production units to the normal production capacity, and the same was certified by an independent Cost Accountant - Refer Page 174 of the paper book for AY 2017-18, and Annex-1 to the synopsis filed for AY 2018-19). On the other hand, the comparable companies selected for the benchmarking analysis were well established companies in a mature stage of business, operating in the industry for several years ranging from 30-40 years with an average age of 32 years (refer Annex 3 to the synopsis filed). Hence, to enhance the comparability between the Assessee and

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other comparable companies, a capacity utilization adjustment was made to the operating margins of the Assessee (Refer Page 89 of paper book). Given the inherent limitation of the non-availability of data relating to the capacity utilisation of the Comparable Companies in the public domain, the Assessee carried out an adjustment by carving out the unabsorbed portion of its fixed operating costs that are non-allocable (idle capacity costs) from operating cost base for computing its adjusted operating margin of 5.8% for AY 2017-18 and 2.53% for AY 2018-19 (Refer Page 94 of paper book for AY 17-18 and Annex 2 for AY 18-19). The said method adopted by the Assessee, i.e., adjusting its own PLI (i.e., PLI of the tested party) to neutralise the impact of the unabsorbed fixed operating costs, the recovery of which is directly dependent on scaling up the production volume, is widely accepted and is supported by the Income- Tax Rules as well as judicial precedents rendered in similarly placed cases. Rule 10B(3) read with Rule 10B(1)(e) of the of the Income Tax Rules, 1962 (‘the Rules’) permit and mandate adjustments on the tested party in the absence of reliable data for the comparable companies: a. Rule 10B(1)(e) of the Rules state that adjustments should be made to account for, inter alia, 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", and b. Rule 10B(3) of the Rules provides that an uncontrolled transaction is comparable to an international transaction only if — (i) none of the differences between the said transactions are likely to materially affect the price charged/paid for such transactions in the open market; or (ii)

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reasonably accurate adjustments can be made to eliminate the material effects of such differences. Further, Para 6.48 of the Guidance Note on Report under Section 92E of the Act (Transfer Pricing), issued by the Institute of Chartered Accountants of India (‘ICAI’), states that it would be important to compute the profitability from manufacturing activity after removing unabsorbed fixed costs (to bring the capacity utilisation of the taxpayer in line with that of the comparable companies) to achieve a meaningful comparison. This has also been upheld in the following decisions: Particulars Forum Citation Page No. in Case Law Compilation Petro Araldite (P.) Ltd. Bombay High 256 Taxman 16 1 Court Radhashir Jewellery Bombay High ITA No. 1209 of 5 Court 2017

B. Initial years of operation The need for a capacity adjustment in the above facts is well demonstrated by the Assessee, i.e., it is in the start-up phase of its operations. In comparison to the number of years and the mature-phase of operations of the comparable companies, the low recovery rate of the fixed costs (Employee benefits expenses, depreciation, rent, rates and taxes, insurance, etc) in the case of the Assessee is directly attributable to the under-utilized capacity, which materially affects its operating margin. Further, neither the need for a capacity adjustment nor the utilisation details furnished by the Assessee are disputed by the TPO. The only contention of the TPO for rejecting the said claim is based on a misguided

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understanding of the rules, i.e., that an adjustment is permitted to be made only in respect of the uncontrolled transactions and not to the PLI of the tested party (Refer Para 5.7 in Page 11 of the TP Order – enclosed in Page 64 of the Memorandum of Appeal). Once it is established that there is a difference that materially affects the comparability of the Assessee and the comparable companies, an adjustment shall be made in order to determine the ALP based on the said comparable companies. In the absence of such adjustment, the said companies (and their uncontrolled transactions) cannot be considered as comparable for benchmarking the Assessee’s margins. 2. The allowability of the capacity utilization adjustment was upheld in the following cases: - *Radhashir Jewellery Co. Pvt. Ltd (Bombay High Court) – Page 5 of Case Law Compilation - Caterpillar India (P.) Ltd (Chennai Tribunal) - Page 9 of Case Law Compilation - *Mando India Steering Systems (P.) Ltd. (Chennai Tribunal) – Page 25 of Case Law Compilation - *Nippon Paint India Pvt. Ltd. (Chennai Tribunal) – Page 29 of Case Law Compilation - *Terex India Pvt. Ltd. (Delhi Tribunal) – Page 35 of Case Law Compilation - *Hitachi High Technologies (Singapore) Pte. Ltd. (Delhi Tribunal) – Page 155 of Case Law Compilation * Deals specifically with idle capacity adjustment claimed in initial years of operations. C. Non-availability of data should not result in the denial of an eligible benefit In this regard, the Assessee submits that it was practically impossible for the Assessee to obtain the said data of the comparable companies which

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are not available in the public domain. In such circumstances, the valid course of action that the TPO ought to have adopted is to either: a. use the powers bestowed on him under section 133(6) of the Act to obtain the said information from the comparable companies to make the necessary adjustment; or b. consider the Assessee’s method of carrying out the adjustment (especially when all the relevant material was furnished and was available before the TPO), and to accept or modify the same based on a reasoned approach. The TPO failed to adopt either of the said options, failing to appreciate that Rule 10B(3) read with Rule 10B(1)(e) of the Rules permits and mandates adjustments on the tested party in the absence of reliable data for the comparable companies. In this regard, the coordinate bench of the Hon’ble Tribunal, in the case of IKA India Private Limited (98 taxmann.com 312) (Refer Page 125 of case law compilation) categorically held: “The Assessee has under-utilized capacity during the subject AY and is accordingly factually and legally eligible to an adjustment for the same, such a benefit cannot be denied 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.” – (Para 33, pg. 136 of the case law compilation) The Hon’ble Bombay High Court in the case of Radhshir Jewellery (ITA No. 1209 of 2017) – Page 5 of Case Law Compilation dismissed the revenue appeal by answering the question of law in favour of the Appellant thereby upholding that the net profit margin of the tested party could be suitably

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adjusted to facilitate its comparison with other uncontrolled transactions. This principle has also been upheld in the following decisions: Particulars Forum Citation Page No. of Case law compilation Ariston Thermo India Limited Pune Tribunal ITA No. 1455/PN/2010 67 Terex India Pvt. Ltd. Delhi Tribunal ITA No. 6775/DEL/2016 35 Toyota Tsusho India (P.) Ltd. Bangalore 139 taxmann.com 433 138 Tribunal Kyocera CTC Precision Tools Kolkata Tribunal 153 taxmann.com 604 104 (P.) Ltd.

said ruling did not delve in the merits of any specific case, and therefore, the same is not relevant in the facts and circumstances of the present case. Considering the above, it is prayed by the assessee that the TPO may be directed to allow capacity utilization adjustment while computing operating margins of the Assessee. 9. We have heard the rival submissions and perused the materials on records, applicable case laws, written submissions filed. The Assessee, Hitachi Astemo Chennai Private Limited (formerly known as Hitachi Automotive Systems (India) Pvt. Ltd.), is a wholly owned subsidiary of Hitachi Astemo Limited, Japan. It is engaged in the manufacturing of automotive components in India and commenced its commercial operations in October 2015. During AYs 2017- 18 and 2018-19, the Assessee entered into international transactions with its AEs for purchase of raw materials. The Assessee adopted the Transactional Net Margin Method (TNMM), selecting itself as the tested party and used Operating Profit to Operating Income (OP/OI) as the Profit Level Indicator (PLI). The Transfer Pricing Officer (TPO), however, rejected the capacity utilization adjustment claimed by the Assessee and made adjustments of Rs.8.52 crores for AY 2017-18 and Rs.6.35 crores for AY 2018-19. The same was partly confirmed by the CIT(A). Aggrieved, the Appellant is before us. 10. Ground of Appeal (AYs 2017-18 and 2018-19): The sole issue for consideration in both years is whether the Assessee is eligible for a capacity utilization adjustment to account for under-utilization of its manufacturing capacity during its initial years of operations. The Assessee’s operations during the relevant assessment years were in their start-up phase, and the capacity utilization was markedly low at 20.31% and 35.39%. The under-absorption of fixed costs during such phase is a recognized commercial reality that materially affects profitability. The methodology adopted by the Assessee adjusting its own margins by removing the impact of idle capacity is both reasonable and in accordance with law.

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Rule 10B(1)(e) read with Rule 10B(3) permits such adjustments to account for differences which materially affect the profit margin. The contention of the TPO and the Ld. DR that adjustments can be made only to comparables and not to the tested party is misplaced and contrary to judicial precedent referred supra. In Petro Araldite Pvt. Ltd. and Radhashir Jewellery Pvt. Ltd., the Hon’ble Bombay High Court has upheld the permissibility of adjusting the tested party’s margins to improve comparability. We also note that the coordinate benches of this Tribunal in multiple decisions, including Mando India Steering Systems, Terex India, and IKA India Pvt. Ltd., have categorically upheld the right of a taxpayer to claim idle capacity adjustments, especially in the initial years of operations. The reliance placed by the Ld. DR on Hon’ble Supreme Court judgment in the case of SAP Labs referred supra is misplaced. The said decision addresses the maintainability of appeals on substantial questions of law and does not deal with the issue of idle capacity adjustments on merits. In the present case, the TPO neither sought additional data using his powers under Section 133(6) nor did he attempt to reasonably evaluate the adjustment methodology adopted by the Assessee. In such a scenario, where data for comparables is unavailable, denial of the benefit to the tested party is unwarranted. In lthe facts and circumstances of the case we are of the considered opinion that the Assessee is factually and legally entitled to a capacity utilization adjustment for both AY 2017-18 and AY 2018- 19. Hence, the TPO is directed to recompute the ALP of the Assessee’s international transactions after granting appropriate idle capacity adjustment as per the methodology submitted. 11. In the result, both appeals of the Assessee for AY 2017-18 and AY 2018- 19 are allowed. Order pronounced in court on the 08th day of September, 2025, in Chennai.

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Sd/- Sd/- (एस.आर.रघुनाथा) (मनु कुमाि गिरि) (S. R. RAGHUNATHA) (MANU KUMAR GIRI) लेखा सदस्य/ACCOUNTANT MEMBER न्यानयक सदस्य/JUDICIAL MEMBER चेन्नई/Chennai, ददनांक/Dated: 08th ,September, 2025. KB/- 1. अपीलार्थी/Appellant 2. प्रत्यर्थी/Respondent 3. आयकरआयुक्त/CIT, Chennai / Madurai / Salem / Coimbatore. 4. विभागीयप्रविविवि/DR 5. गार्डफाईल/GF

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