M/S TOKAI RIKA MINDA INDIA PVT LTD ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CICLE-7(1)(1), BANGALORE

PER CHANDRA POOJARI, ACCOUNTANT MEMBER:

This appeal by assessee is directed against the final assessment order dated 28.4.2017 passed u/s 143(3) r.w.s. 144C(13) of the Act passed in consequence to the direction of Ld. Dispute Resolution Panel (“DRP”) dated 14.3.2017. The assessee raised various grounds which reads as under:-

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Page 2 of 26 “The grounds mentioned hereinafter are without prejudice to one another. 1. The learned Assessing Officer ("learned AO"), learned Transfer Pricing Officer ("learned TPO") and the Honourable Dispute Resolution Panel ("Hon'ble DRP") have grossly erred in in law and facts of the case by proposing a transfer pricing adjustment of INR 5,67,47,747/-under section 92CA of the Income-tax Act, 1961("the Act") with respect to the international transactions rendered by the Appellant during AY 13-14. 2. The learned AO/learned TPO/Hon'ble DRP erred in rejecting the Transfer Pricing ("TP") documentation maintained by the Appellant by invoking provisions of sub-section (3) of 92C of the Act. 3. The learned AO/learned TPO / Hon'ble DRP have erred in disregarding the economic analysis performed by the Appellant in the TP documentation in justification of the arm's length nature of the international transactions entered by it with its Associated Enterprises. 4. The learned AO/ learned TPO /Hon'ble DRP erred in considering losses on foreign exchange fluctuation as operating in nature. 5. The learned AO/learned TPO/Hon'ble DRP erred in not allowing adjustment on account of custom duty and surcharges incurred by the Appellant. 6. The learned AO/learned TPO/Hon'ble DRP erred in not allowing purchase price adjustment. 7. The learned AO/learned TPO/Hon'ble DRP erred in ignoring the fact that different companies adopt different rates for various asset categories while computing depreciation and the data. pertaining to the same is not available in the public domain. Accordingly, the learned AO/learned TPO/Hon'ble DRP erred in not excluding depreciation while computing the operating margin of the Appellant and the comparable companies. 8. The learned AO/ learned TPO /Hon'ble DRP has failed to appreciate the fact that the Appellant is only in its third year of operations which has resulted in under-recovery of fixed cost owing to initial year of operations. 9. The learned AO/ learned TPO/ Hon'ble DRP has failed to appreciate the fact that the Appellant has not fully and optimally utilized its installed capacity, which has resulted in the Appellant incurring huge expenses during the year. 10. The learned AO/ learned TPO /Hon'ble DRP erred in not appreciating the fact that since the comparable companies proposed by the learned TPO are well established in the industry, appropriate adjustment on account of under- utilization of capacity ought to be granted for proper comparability analysis.

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Page 3 of 26 11. The learned AO/learned TPO /Hon'ble DRP erred in not allowing working capital adjustment. 12. The learned AO/learned TPO/Hon'ble DRP erred in not allowing appropriate adjustment to account for the difference in the risks borne by the Appellant and the comparable companies. 13. The Appellant reserves the right to apply the provision to Section 92C(2), wherein if the variation between the arm's length price and the price at which the international transaction has been undertaken does not exceed 3% of the later, then the international transaction would be deemed to be at arm's length.”

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difference between the contracted price and the actual price of delivery due to forex fluctuation. The assessee also sought adjustment for fluctuation for reinstatement of foreign currency as per accounting standards. According to the assessee, TPO has not given any reason for reduction of purchase price adjustment except to state that it makes no sense. According to the Ld. A.R. the purchase of assessee have import component of 75% and there is a peak difference between the purchase price of the assessee and all the comparables. A proper comparability analysis should factor the same. It is also brought to our notice that loss due to the fluctuation which are in the revenue field are to be treated as operating in nature and those which pertain to earlier years/reinstatement are to be treated as non-operating in nature. The TPO has treated entire loss due to foreign exchange fluctuation as operating in nature. Accordingly, he sought suitable direction on this issue.

5.1. The Ld. D.R. relied on the order of the lower authorities.

5.2. We have heard the rival submissions and perused the materials available on record. Admittedly, similar issue came for consideration before this Tribunal in assessee’s own case in IT(TP)A No.2327/Bang/2016 for the assessment year 2012-13. The Tribunal vide order dated 8.4.2012 held as under:- 9. “On issue of foreign exchange fluctuations adjustment, we observe that the TPO and the DRP have not properly analyzed 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 analyzed. In the given facts and circumstances of the case, we are of the view that it would be just and appropriate to set aside

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Page 5 of 26 the impugned Order on this issue and remand the issue to the TPO.”

5.3. In view of the above order of the Tribunal, we are inclined to remit the issue to the file of TPO on similar directions.

6.1. After hearing both the parties, similar issue was considered by Bangalore bench in the case of Continental Automotive Components India Pvt. Ltd. Vs. ACIT in IT(TP)A No.713/Bang/2017 dated 24.11.2021, wherein it was held as under:- 25. The grievance of the assessee by this ground is that the DRP erred in not granting adjustment towards custom duty expenses. The assessee has incurred significant customs duty charges which are proportionately much greater than that of the comparable companies leading to a lower profitability for the assessee. The comparable companies have not incurred any significant custom duty expense as they primarily manufacture using materials available indigenously within India. It is submitted that the assessee is still in the process of localizing its manufacturing process. To meet the quality standards and to overcome technological challenges, the assessee imports raw materials from its AEs. Therefore, it becomes necessary for the assessee to import raw materials from its AEs which is not the case for the comparable companies, thus, putting the assessee in a comparative disadvantage vis-a-vis the comparables. The TPO rejected the adjustment sought for the reason that the decision to import is a conscious decision taken by the assessee and in the absence of any external factors, beyond the control of the Assessee necessitating imports, no adjustment can be made. The TPO also observed that the import duty is a part of the cost of material which is always included at the time of pricing of the product and also that the assessee ought to have considered the customs duty component payable while negotiating the price at which the raw materials are imported. 26. The DRP has upheld the non-grant of customs duty adjustment on the basis that the arithmetic mean of margins under the TNMM method takes care of such difference.

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Page 6 of 26 27. The assessee submits that the import of raw materials is not a commercial decision but on the other hand is necessitated for reasons beyond the assessee i.e., by lack of capacity to localize the procurement which the assessee is still in the process of doing. Reliance is placed on the following decisions in support of the Appellant’s contentions. • Skoda India Pvt. Ltd. v. ACIT reported in [2009] 30 SOT 319 (Pune) • Putzmeister Concrete Machines Private Limited v. DCIT reported in [2014] 49 taxmann.com 436 (Panaji - Trib.) • Toyota Kirloskar Motors Pvt. Ltd. v. ACIT reported in [2012] 28 taxmann.com 293 (Bangalore)

S Name of the company Impor l ts/Tot N al o purch 1. . ases Automotive Stampings & 0.57 Assemblies Ltd 2. Bajajsons Ltd 5.92 3. Bharat Gears Ltd 2.62 4. JMT Auto Ltd 1.54 5. M&M Auto 0.53 6. Rambal Ltd 2.10 7. Rasandisk Engineering Inds. 4.61 8. Triton Valves 10.81 9. Wheels India Ltd 8.63 10. Mubea Suspension India Ltd 0.02 11. Ring Plus Aqua Ltd 4.75 Average import consumption 3.83

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Page 7 of 26 a. Adjustments are to be made to the margins of the comparable companies to account for differences which could materially affect the amount of net profit margin in the open market. In the case of the assessee, it is the business model by which the assessee imports most of its raw materials from its AEs. The assessee company manufactures goods and sells in India out of raw materials procured from its AEs. This import duty is not a onetime cost which would affect the company's margin as an extraordinary event. b. Import duty per se does not call for an adjustment. It requires to be seen whether the import is necessitated by certain factors beyond the control of the assessee company. If it is the normal business model of the assessee to import goods, it is not an extraordinary event affecting its margin. c. The higher percentage of import content in the assessee's production is a conscious decision taken by the assessee keeping in mind all commercial considerations including the obvious benefits of better quality which is bound to reflect in higher sales margin. d. Import duty is part of the cost of material which is always taken into account in pricing a product. If the individual elements of cost were to be separately adjusted for differences between the tested party and the comparables, then the profit margin of all the companies would become uniform.

e. The assessee company ought to have considered the customs duty component payable while negotiating the price at which the raw materials were imported from the AEs. 30. This issue came up for consideration before the Chennai Tribunal in the case of Gates Unitta India Company (P.) Ltd. v. DCIT, 84 taxman.com 69 wherein it was held as follows:- “5. Before us, ld. A.R submitted that 90% of the raw materials of the assessee are imported as such customs duty adjustments to be made and it includes Rs. 4.31 crores pertained to the customs duty in the manufacturing segment. In principle the customs duty adjustments is allowed in view of the Co-ordinate Bench decision in the case of Motonic India Automotive (P.) Ltd. v. Asstt. CIT [2016] 73 taxmann.com 235 (Chennai - Trib.) wherein held that: '6.1 At this stage, it is pertinent to mention the finding of the Pune Bench in the case of Demag Cranes & Components (India) Pvt. Ltd. v. DCIT (supra) dated 4.1.2012 in ITA No.120/PN/2011, which is as follows :

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Page 8 of 26 "37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). It is relevant mentioned that we have already analysed the relevant provisions of Income Tax rules vis a vis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of the 'working capital'. In principles, our findings on the issue remain applicable to the adjustments on account of the import cost mentioned in ground 4(b) too. The difference between the AL Margin before and after the said adjustments on account of 'import cost' works out to 0.57% (7.18%- 6.61%). Revenue has not disputed the said working of the assessee. In these factual circumstances and in the light of the scope of adjustments discussed above, in our opinion and in principle, the assessee should win on this ground too. One such decision relied upon by the assessee's counsel supports our finding relates to the decision of this bench of the Tribunal in the case of Skoda Auto India p Ltd 122 TTJ 699 (Pune) dated March 2009 wherein, it is held (in para 19 of the order) that,- "No doubt , a higher import content of raw material by itself does not warrant an adjustment in operating margins, as was held in Sony India (P) Ltd.'s case (supra), but what is to be really seen is whether this high import content was necessitated by the extraordinary circumstances beyond assessee's control. As was observed by a Co-ordinate Bench of this Tribunal in the case of E-Gain Communication (P) Ltd. (supra) "the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the open market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect". We do not agree with the AO that every time the assessee pays the higher import duty, it must be passed on to the customers or it must be adjusted for in negotiating the purchasing price. All these things could be relevant only when higher import content is a part of the business model which the assessee has consciously chosen but then if it is a business model to import the SKD kits of the cars, assemble it and sell it in the market, that is certainly not the business models of the comparables that the TPO has adopted in this case. The adjustments then are required to be made for functionally differences. The other way of looking at the present situation is to accept that business model of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments are thus required either way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison possible. The assessee cannot be expected to get the details and particulars which are not in publicdomain. In such a situation, i.e. when information available in public domain is not sufficient to make these comparisons possible, it is inevitable that

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Page 9 of 26 some approximations are to be made and reasonable assumptions are to be made. The argument before us was that it was first year of assessee's operations and complete facilities ensuring a reasonable indigenous raw material content was not in place. The assessee's claim is that it was in these circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car was computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were before any of the authorities below. What was argued before the AO was mere fact of higher costs on account of higher import duty but then this argument proceeded on the fallacy that an operating profit margin for higher import duty is permissible merely because the higher costs are incurred for the inputs. That argument has been rejected by a Coordinate Bench and we are in respectful agreement with the views of our esteemed colleagues. This additional argument was not available before the authorities below and it will indeed be unfair for us to adjudicate on this factual aspect without allowing the TPO to examine all the related relevant facts. We, therefore, deem it fit and proper to remit this matter to the file of the TPO for fresh adjudication in the light of our above observations." 38. The perusal of the impugned orders shows that the above cited guidelines by way of decision of this bench of the Tribunal in the case of Skoda Auto India p Ltd (supra) were not available to the revenue authorities. Therefore, we are of the opinion, the issue should be set aside to the files of the TPO with direction to examine the claim of the assessee relating to the import cost factor and eliminate the difference if any. However, the TPO/AO/DRP shall see to it that the difference in question is 'likely to materially affect' the price/profit in the open market as envisaged in sub rule (3) of Rule 10B of the Income tax Rules, 1962. Accordingly, ground 4(b) is allowed pro tanto.' Accordingly, we direct the A.O. to give suitable adjustment against the custom duty component while determining the ALP.' Hence, to bring uniformity, the customs duty was to be eliminated from the comparable price also to arrive at correct PLI. Accordingly, we remit the issue to the file of AO for fresh consideration.” 31. In view of the above finding of the Tribunal in Gates Unitta India Company (P.) Ltd. (supra), we are inclined to remit this issue to the AO/TPO with similar directions.”

6.2. In view of the above, we remit the issue to the file of AO/TPO for fresh consideration on similar lines.

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7.1 After hearing both the parties, we are of the opinion that similar issue was considered by this Tribunal in assessee’s own case cited (supra), wherein it was held as under:- 10. “On the issue of depreciation adjustment, the assessee has submitted that if the rates of depreciation are different between the tested party and the comparable companies, an adjustment has to be made for the same in the comparability analysis. In this regard, the assessee has relied on the decision of the Tribunal in the case of Outsource Partners Ltd IT(TP)A No.2171IBang/2019, wherein it is observed as follows:-

“4.4 From the above order of the Tribunal, it is clear if there is difference in depreciation in the case of assessee and the comparable cases, reasonable depreciation adjustment is to be made to determine the arm'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 reexamined by the TPO / AO afresh. The assessee should demonstrate whether there is any difference in depreciation policy of the assessee and the comparable companies and what

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Page 11 of 26 is its impact on the computation of arm's length price. If the assessee is able to demonstrate the same, the TPO may allow reasonable depreciation adjustment while determining the ALP for the international transactions.”

7.2. In view of the above order, we remit the issue to the AO/TPO for fresh consideration.

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Page 12 of 26 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 10B of the Rules. Rule 10B in turn states that the most appropriate method would be one which inter alia provides the most reliable measure of ALP, and one of the important factors to be taken into account herein is the ability to make reliable and accurate adjustments.

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 contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties." 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)

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Page 13 of 26 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 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. Hence in case appropriate adjustments cannot be made to the uncontrolled transaction, due to lack of data, then in order to read the provisions of transfer pricing regulations 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/De1/2011), it was held that:-

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Page 14 of 26 "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 turn, results in lower profits. Of course, the 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-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 under-utilization 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 manpower is

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Page 15 of 26 given. The assessee should also be given adjustment for under utilization 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 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)] 30. 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.

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Page 16 of 26 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 under this Act :" 32. In this regard, we find that the Mumbai ITAT in case of M/s Kiara 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 Variable Cost; • Segmental/ product wise information, if any. 34. 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.” 13. Accordingly, we set aside the issue to the files of the AO / TPO directing to follow the directions given in the case of IKA India (P.) Ltd. v. ACIT (supra).”

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8.1. Respectfully following the above order of the Tribunal, we remit the issue to the file of AO/TPO on similar direction.

9.1 After hearing both the parties, we of the opinion that similar issue came for consideration before this Tribunal in assessee’s own case, wherein the Tribunal held as under:-

“14. The next grievance of the assessee is not granting of working capital adjustment. We have considered the rival submissions and perused the material on record, including the judicial pronouncements cited. We find that the assessee has filed the computation of working capital adjustment before the DRP, but the DRP has not considered the same. We also find that the Co-ordinate Bench of this Tribunal in the case of Huawei Technologies India (P.) Limited 101 taxmann.com 313 has discussed all the reasons on the issue and held that working capital shall be allowed; holding as under at paras 10 to 18 thereof:-

“10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT (A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act in so far 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) to (b)** (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

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Page 18 of 26 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 transactions 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) 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 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 capitalin the markets, overall economic

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Page 19 of 26 development and level of competition and whether the markets are wholesale or retail.

(3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic 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. 11. A reading of Rule 10B(l)(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 OECD 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 OECD 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. 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

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Page 20 of 26 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 andlor benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect. 15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (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 to suppliers."

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Page 21 of 26 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 to improve the reliability of the comparables.

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Page 22 of 26 The Revenue 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 Serve.com [2016J 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 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 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.

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Page 23 of 26 the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by CIT (A) working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the Rules, which provides as follows:

"(3) 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 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.” 15. 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 actual on the final set of comparables. The TPO / AO are accordingly directed.”

9.2 Respectfully following the above order of the Tribunal, we remit the issue to the file of AO/TPO on similar lines.

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Additional ground: 11. Ground No.14 is additional ground raised by the assessee, which reds as follows:- “The Learned TPO/AO has erred in not restricting the transfer pricing adjustment to the international transactions. The Appellant has substantial transactions with third parties which are outside the purview of determination of arm’s length price.

Even if a transfer pricing adjustment is to be proposed, the same should be restricted only to the international transactions entered into during the year. It is a settled principle that adjustment is to be restricted to the international transactions alone. Therefore, your petitioner submits that the additional ground No.14 be admitted.”

11.1. The Ld. AR. pleaded to admit the additional ground on the reason that inadvertently assessee has not raised this ground on earlier occasion and all the facts are already on record which does not require any investigation of fresh facts and prayed that additional ground may be admitted.

11.2 After hearing both the parties, we are of the opinion that all the facts are already on record and there is no necessity of investigation of fresh facts otherwise on record. Accordingly, these additional grounds are admitted by placing the reliance on the judgement in the case of NTPC Vs. CIT reported in 229 ITR 383. After admitting the additional grounds, we are of the opinion that this issue squarely covered by the earlier order of the Tribunal in assessee’s own case cited (supra), wherein it was held as under:

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Page 25 of 26 “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.”

11.3 In view of the above order of the Tribunal, we remit this issue to the file of AO/TPO for fresh consideration.

Sd/- Sd/- (Beena Pillai) (Chandra Poojari) Judicial Member Accountant Member

Bangalore, Dated 29th Jun, 2022. VG/SPS

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Page 26 of 26 Copy to:

Asst. Registrar, ITAT, Bangalore.