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Income Tax Appellate Tribunal, “D” BENCH, AHMEDABAD
Before: SHRI WASEEM AHMED
आदेश / O R D E R
PER WASEEM AHMED, ACCOUNTANT MEMBER: The captioned appeal has been filed at the instance of the Assessee against the order of the Commissioner of Income Tax (Appeals)–1, Vadodara [CIT(A) in short] vide appeal no.CAB-1/78/2014-15 dated 18.02.2016 arising in the matter of assessment order passed under Sec.143(3) r.w.s. 144C(1) of the Income Tax Act, 1961(here-in-after referred to as "the Act") dated 02.05.2013 relevant to Assessment Year (AY) 2009-10.
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
The grounds of appeal raised by the assessee are as under:- “Each of the grounds and/ or sub-grounds of the appeal are independent and without prejudice to the others. Ground No.1: 1.1. On the facts and in the circumstances of the case and in law, the Hon'ble Commissioner of Income-tax (Appeals)-1 ['the CIT(A)'] erred in confirming the vitiated Assessment Order passed by the Asst. Commissioner of Income-tax, Range 1(2) ('Assessing Officer' or 'AO') as the Ld. AO erred both in factsand in lawn making an addition to the Appellant's total income.
The Appellant prays that the assessment order passed by the AO be quashed. Ground No. 2
2.1. On the facts and in the circumstances of the case and in law, the assessment order dated 2 May 2013 passed by the Ld. Assessing Officer under Section 143(3) read with Section 1440(1) of the Act (received by the Appellant on 31 July 2013) is time barred and therefore, bad in law.
The Appellant prays that the assessment order passed by the AO be quashed.
Ground No. 3: 3.1 On the facts and in the circumstances of the case and in law, the AO/Transfer Pricing Officer (TPO)/ CIT(A) erred in making/confirming the upward adjustment of INR 1,90,93,083 to the income of the Appellant, in respect of transaction in relation to export of finished goods to Associated Enterprises, by: a. rejecting the transfer pricing documentation prepared by the Appellant; b. rejecting the use of multiple year data for benchmarking the transaction in relation to the export of finished goods;
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 3 - c. rejecting the Profit Level Indicator ('PLI') used by the Appellant (i.e. return on cash cost); 3.2 On the facts and in the circumstances of the case and in law, the AO/ TPO/ CIT(A) erred in not considering the differential level of economic activity between the Appellant and the comparables (i.e. difference in capacity utilisation). 3.3 On the facts and in the circumstances of the case and in law, the AO/ TPO/ CIT(A) erred in considering interest rate of 12.75% (i.e. Prime Lending Rate) instead of the Appellant's contention of applying short term deposit rate while computing working capital adjustment. The Appellant prays that the addition of INR 1,90.93,083 be deleted.
Ground No. 4: 4.1. On the facts and circumstance of the case and in law. the AO erred in initiating penalty proceedings under Section 271(1)(c) of the Act. The appellant craves leave to add, omit or alter grounds of appeal before or during the hearing of aforesaid matter.” 3. The ground no.1 is general and does not require any separate adjudication. Therefore, the same is dismissed.
At the outset, ld. Counsel for the assessee submitted that he had been instructed not to press the ground no.2 and ground no. 3.3, therefore we dismiss the same as not pressed.
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 4 - 5. The only effective issue raised by the assessee is that ld. CIT(A) erred in confirming the order of AO by not adjusting the amount of depreciation claimed by it in determining the PLI .
Briefly stated facts are that the assessee is a private limited company and engaged in the business of manufacturing of Guar gum and cassia gum powder. The assessee during the year has made sales to its associated enterprises namely Lubrizol Advanced Materials Europe BVBA amounting to Rs. 27,60,04,106/-. The assessee claimed to have determined the ALP of the transaction with its AE regarding the sale of finished goods using TNMM Method.
6.1 The assessee has taken operating profit without depreciation, i.e. PBDIT to total cost for deciding the profit level indicator for the purpose TNMM analysis. Accordingly, the assessee worked out PLI for its export of goods to its AE @ 20.58%.
6.2 The assessee worked out average PLI of the comparable companies @ 8.81%. In view of above, the assessee claimed that it had sold goods to its AE at arm’s length price and no adjustment was required.
However, the TPO was not satisfied with the method of determining the PLI as operating profit (PBDIT) to total cost as the profit level indicators.
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 5 - As per the TPO, the operating profit (PBIT) to operating cost should have been taken as PLI. Accordingly, the AO proposed to determine the PLI of the assessee at (-)1.05%. On a question by the TPO, the assessee submitted that it had claimed excess depreciation, therefore, the same needs to be adjusted while determining the PLI. Accordingly, the assessee proposed to adjust the depreciation amounting to Rs.1,57,49,979/- only.
6.3 Besides the above, the assessee also submitted that it had purchased new plant & machinery under the year under consideration which has not been utilized at the optimum level. As such these plant and machinery have been utilized only to the extent of 6.81% of its total capacity. Therefore, adjustment on account of depreciation as well as a salary to the employees working in the plant on account of low capacity should be allowed. However, the TPO disagreed with the submission of the assessee and worked out the arm’s length price as under: “7. The calculation of the arms length price is as below:
Operating Cost as per show cause Rs.31,93,76,058/- Less: Depreciation adjustment Rs.1,57,49,979/- Operating Cost Rs.30,36,26,079/- Arms Length adjusted Mean margin 10.18% of the Operating Cost Arms Length Price(ALP) @110.18% of Rs.33,45,35,214/- operating cost Price received Rs.31,54,42,131/- Shortfall being adjustment u/s 92CA Rs.1,90,93,083/- 5% of the ALP determined by assessee Rs.138,00,206/-
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 6 - Since the difference between the ALP and the price shown in the books of accounts is more than 5% of the price shown in the books of accounts, the above adjustment is proposed.”
In view of the above, the TPO made adjustments of Rs. 1,90,93,083/- on account of sales made to the AE. The above adjustment was duly incorporated by the AO in his assessment order passed u/s 143(3) r.w.s144C of the Act vide order dated 2nd May, 2013.
Aggrieved, assessee preferred an appeal to ld. CIT(A). The assessee before the ld. CIT(A) submitted that its plant and machinery had been utilized to the extent of Rs. 6.81% only, therefore, there has to be an adjustment on account of depreciation claimed by it in determining the PLI of the Assessee with the comparable companies.
7.1 The assessee also submitted to the ld. CIT(A) for providing adjustment of the employee cost working in the plant and machinery. However, the ld. CIT(A) disregarded the contention of the assessee and confirmed the order of AO by observing as under: “6.4.1 A perusal of the order of TPO shows that he had disallowed this claim by stating that exactly similar issue was involved in the case of Haworth (India) Pvt. Ltd. vs. DCIT(2011) Taxmann.com 76 (Death). In this judgment the Hon’ble Tribunal denied the adjustment in respect of capacity utilization asked for by the assessee, In that case the company assumed capacity utilization of 70% in the case of comparables and sought to adjust its net profit margin on the basis of the same. The Hon'ble tribunal rejected the claim of the assessee on the basis that the net profit of the assessee can't be changed. The adjustment, if required to be carried out, is to be made in the financials of the comparables. In the instant case the assessee has not produced any calculation in
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 7 - respect of such adjustment by making a comparison with the capacity utilization of the comparables and by making adjustments in the Financials of the comparables. 6.4.2 During the course of the appellate proceedings also, no such computations regarding the comparables were filed. The appellant has only filed that the capacity utilization of the comparables are available in their audited reports. But in the absence of workings as discussed by the TPO in his order, no such adjustment cap be granted to the appellant. Hence this ground of appeal is also dismissed.” Being aggrieved by the order of ld. CIT(A) assessee is in appeal before us.
The ld. AR before us submitted as under: Appellant's submission - i) Use of Cash PLI During financial year 2007-08 the Appellant had set up a new manufacturing plant called MPP plant for manufacture of products such as Rheoranger and Mountain CAT. The huge additions made in FY 2007-08 & 2008-09 on its new MPP plant lead to a high amount of depreciation being charged to its profit & loss account (forming 13.68% of total operating cost). Further, the MPP plant was severly underutilized (less than 7%) due to production related issues. Considering huge differences in depreciation between the Appellant and comparable companies and the low utilisation of assets, the depreciation cost cannot be considered for calculating operating profits. In view thereof, the Appellant submits that Cash PLI is the appropriate PLI for benchmarking its manufacturing segment. The Appellant places reliance on the following decision in support of its contention:
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- CIT vs. BA Continuum India Pvt. Ltd (ITA No 449 of 2014) (Andha Pradesh & Telangana HC) - BA Continuum India Pvt. Ltd. Vs. ACIT (ITA No. 1154/Hyd/2O11) (Hyd. Trib.) - Schefenacker Motherson Ltd. Vs. ITO [2009] (123 TTJ 509) (Del. Trib.) - Erhardt Liemer India Pvt. Ltd. vs. ACIT [2017] (78 Taxman.com 258) (Ahd. Trib.)
Conclusion II the Appellant's contention of using Cash PLI as an appropriate PLI is accepted, the Appellant's transactions would 1 at arm's length since the Appellant has earned a higher margin than that of comparable companies as shown in the table below - Company Name Cash PLI margin Cash PLI margin (WCA) Hindustan and Chemicals Ltd. 11.78% 17.79% Gums Jai Bharat Gums & Chemicals 3.58% 9.15%
Mean/ALP 7.68% 13.47% Appellant's margin (Refer pg. 82 of 20.58% 20.58% paperbook)
The ld. DR before us submitted as under: “The rejection of documentation prepared by taxpayer using multiple year data without using data relating to the year under consideration is not in accordance with provisions of law and as a result of the same information and document used in justification of arms length price by taxpayer becomes incorrect and/or unreliable and rejected under the provisions of section 92C(3)(c). Further, since (lie taxpayer is involved in sale of products to its AE, which are in the export market, the selection of comparables which do not have significant export sales again renders the information used for the benchmarking as incorrect.
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 9 - Since the assessee and AE operate in India and Europe, the comparables are required to be selected which are engaged in providing the operation in similar jurisdiction. Para 3.43 of transfer pricing guidelines issued by OECD in 2010 also lists out this criteria as one of the most commonly used qualitative criteria for selection of comparables.
Selection of entities having predominantly domestic operations and use of multiple year data, without using data for the year under consideration renders entire EP documentation prepared by taxpayer been correctly rejected under Section 92C(3)(c).
The taxpayer submitted that due to severe under-utilisation in capacity of plant in the year under consideration, there was huge impact on depreciation resulting in very high ratio of depreciation to total operating cost as compared to comparables. In order to have compatibility, depreciation should be taken out from comparability analysis and consequently PBDIT/OP cost should be considered as relevant PLI. The contention of assessee to exclude depreciation from calculation of operating margin is not acceptable. If depreciation is taken out from calculations then there is no compatibility of intensity of asset utilization in FAR. Consequently, non consideration of depreciation for purpose of comparison of net margins is erroneous. Thus the assessee's contention to consider PBDT/Total cost as the profit level indicator is rejected.
For proper appreciation of the submission of the assessee it had to be seen that what evidence had been filed by the assessee with regard to assumption made by it with regard to capacity utilization of 70 percent of the comparables. It was the legal obligation of the assessee to keep and maintain the information and documents in respect of any assumption made by it which according to assessee had critically affected the determination of arm's length price. None of the documents relied upon by the assessee described the capacity utilization by comparables. Thus it was wrongly claimed by the assessee that it had furnished sufficient evidence with regard to capacity utilization. Thus it was held that assessee had not been able to furnish credible and accurate information with regard to capacity utilization and such
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 10 - adjustment could be allowed only in a case where assessee is able to furnish accurate and credible evidence in this regard. Therefore the said ground of the assessee was to be rejected (Para 90). Relying on the above judgment the adjustment related to capacity utilization as called for by the, assessee is rejected.”
We have heard the rival contentions and perused the materials available on record. It is undisputed fact that in the previous assessment year the assessee has determined PLI after taking the profit before interest & tax and after taking into consideration the depreciation. However, the fact of the present case is different from the case of the earlier years. It is because the assessee has claimed depreciation in the year under consideration on the plant and machinery which has not been effectively utilized. Therefore, in our considered view, the adjustment on account of depreciation is required in deciding the PLI.
10.1 Similarly, the case law relied on by the AO is factually different from the facts on hand. In that case, the capacity of the plant and machinery was assumed @70% whereas in the instant case the capacity utilized by the assessee is only 6.81%. Therefore, in our considered view we cannot make any reference to the case law relied by the AO.
10.2 Besides the above, we find that the Ahmedabad Tribunal in the case of Erhardt + Leimer (India) Ltd vs. ACIT reported in 78 taxmann.com 258 involving the identical facts & circumstances has decided the issue in favour of the assessee. The relevant extract of the order is reproduced as under:
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 11 - “11. The assessee's only substantive argument raised in the course of hearing is that the authorities below have not granted it capacity underutilization benefit in respect of the above import of component transactions. We notice at this stage that the relevant facts pertaining to the instant issue are in a narrow compass. The assessee pleaded before the Transfer Pricing Officer that it had set up new installed capacity of manufacturing of 11520 machines as against the consequential production of 4133 sets thereof only. It sought to seek underutilization adjustment since it could manufacture only 35% of the installed capacity leaving behind 65% as unutilized. The Transfer Pricing Officer as well as the Dispute Resolution Panel declined this relief on the ground that such a course of action of making adjustment in the hands of comparable entities is nowhere provided in the Act or the Rules framed thereunder. All this resulted in the impugned transfer pricing adjustment addition being made in assessee's hands. 12. We have given our thoughtful consideration to rival contentions. There is admittedly no dispute about the fact that assessee's 65% manufacturing capacity has remained idle in the impugned assessment year. It adopted the transaction net margin method (TNMM) to benchmark its above purchased transaction. There is further no issue between the parties that the above term capacity utilization is a factor affecting net profit margins since it results in higher per unit cost qua the utilized capacity which in turn lowers down the profits in question at a transactional or unit level. Ld. Departmental Representative at this stage vehemently argued that such an adjustment in the hands of comparable entities is nowhere provided either in the Act or Rules. This argument fails to impress us. We find that a co- ordinate bench decision in Dy. CIT v. EDAG Engineers & Design India (P.) Ltd. [2014] 50 taxmann.com 332 (Delhi-Trib) quotes Rule 10B (1)(e)(3) to be providing for adjustments for variation which could materially affect the net profit margins in case of comparable uncontrolled transactions. Ld. Departmental Representative seeks to draw a distinction that the said case law deals with CUP method as against TNMM employed in the instant case. We find that Rule 10B(e)(iii) hereinabove is regarding TNMM method only providing for various adjustments on account of the contemporaneous factors materially affecting the net profits. The above co-ordinate bench thereafter concludes that such capacity under utilization adjustments have to be made only in the hands of comparable
ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
- 12 - entities instead of that in case of tested party itself. We thus accept assessee's instant argument in principle and direct the Transfer Pricing Officer to proceed afresh as indicated hereinabove after affording adequate opportunity of hearing to the assessee.”
In view of the above, we are of the view that the adjustment in deciding the PLI of the assessee on account of depreciation should be given. Therefore, we set aside the order of ld. CIT(A) to the file of TPO to decide the issue afresh after giving the effect of depreciation as per the provisions of law. Hence, the ground of appeal of the assessee is allowed for statistical purposes.
In the result, appeal of the assessee is allowed for statistical purposes. This Order pronounced in Open Court on 15/11/2018
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ITA No.1349/Ahd/2016 Lubrizol Advanced Materials India Pvt. Ltd. vs ACIT A.Y. 2009-10
आदेश क� ��त�ल�प अ�े�षत/Copy of the Order forwarded to : 1. अपीलाथ� / The Appellant 2. ��यथ� / The Respondent. 3. संबं�धत आयकर आयु�त / Concerned CIT 4. आयकर आयु�त(अपील) / The CIT(A)-1, Vadodara. �वभागीय ��त�न�ध, आयकर अपील�य अ�धकरण, अहमदाबाद / DR, ITAT, Ahmedabad. 5. 6. गाड� फाईल / Guard file. आदेशानुसार/BY ORDER, स�या�पत ��त //True Copy// उप/सहायक पंजीकार (Dy./Asstt.Registrar) आयकर अपील�य अ�धकरण, अहमदाबाद / ITAT, Ahmedabad