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Income Tax Appellate Tribunal, “C” BENCH KOLKATA
Before: SHRI SANJAY GARG & SHRI GIRISH AGRAWAL
PER GIRISH AGRAWAL, ACCOUNTANT MEMBER:
This appeal filed by the assessee is against the order of Ld. CIT(A), Kolkata-22, Kolkata vide Order No. ITBA/APL/S/250/2021- 22/1032545945(1) dated 20.04.2021 passed against the assessment order by the DCIT, Circle-1, Kolkata u/s. 143(3)/144(C)(3) of the Income- tax Act, 1961 (hereinafter referred to as the “Act”) dated 15.05.2013.
I.T.A. No. 222/Kol/2021 Witzenmann India Pvt. Ltd., AY 2009-10 2
Grounds raised by the assessee are reproduced as under:
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Before us, Ms. Pallavi Paul, AR appeared on behalf of the assessee and Smt. Ranu Biswas, Additional CIT, DR represented the department.
At the outset, we note that there is a delay of 30 days in filing the present appeal before the Tribunal. Order of Ld. CIT(A) is dated 20.04.2021 which was served on the assessee on the same date. Limitation to file this appeal expired on 20.06.2021. However, the appeal has been filed on 19.07.2021. Petition for condonation of delay is placed on record. It is stated that the period relating to delay falls during the time of Pandemic Covid-19. It is noted that the period of delay falls during the time of Pandemic of Covid-19 which has been excluded by the Hon’ble Supreme Court in the case of Suo moto Writ Petition (C) No. 3 of 2020 dated 10.01.2022 by which the period from 15.03.2020 to 28.02.2022 has been directed to be excluded for the purpose of limitation. Vide this order a further period of 90 days has been granted for providing the limitation from 01.03.2022. Accordingly, we condone the delay and proceed to adjudicate upon the matter.
Further, Ld. Counsel for the assessee stated that without prejudice to other grounds, the assessee is pressing ground nos. 2 and 3 relating to financial adjustments undertaken to eliminate material
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differences in respect of capacity utilization adjustment and working capital adjustment, respectively. The same is also stated in the written submission dated 11.10.2022 filed after the hearing held on 21.09.2022 based on direction given by the Bench.
Brief facts of the case from the records are that assessee is engaged in distribution as well as assembling of industrial products such as metal hoses, expansion joints, metal bellows, pipe supports and hangers, primarily catering to the automotive industry. Assessee started its first unit in Kolkata in the year 2006 wherein it engaged in distribution of industrial products to various industrial plants. Assessee started its second unit in Chennai in 2008 wherefrom it carried on assembly operations, mainly catering to the automotive industry. In respect of this assembly unit, assessee is in the first year of operation in the impugned AY 2009-10 and claimed that it was working at low capacity utilization alongwith adverse working capital level.
6.1. Assessee filed its return of income on 23.09.2009 reporting total income as nil. Case of the assessee was selected for scrutiny for which statutory notices were issued and served on the assessee and were duly complied with. A reference u/s. 92CA(1) of the Act was made by Ld. AO to the Dy. Director of Income Tax (Transfer Pricing Officer-IV), Kolkata (Ld. TPO) for computation of arms length price in relation to international transactions undertaken by the assessee during the year. In respect of the international transactions, Ld. TPO noted that arms length income of the said transactions was not found to be acceptable for which a show cause notice was issued vide its letter dated 15.01.2013. Against this show cause notice, assessee submitted its detailed reply dated 18.01.2013. Assessee had submitted that a detailed transfer pricing analysis was undertaken to determine
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functions performed, risk assumed and assets utilized by it in respect of international transactions executed with its Associated Enterprises (AEs). As part of the analysis, assessee had determined Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) to benchmark the arm’s length nature of the international transactions. In this respect assessee also made adjustment towards its capacity utilization and working capital adjustment to eliminate material differences for the purpose of comparability. Following transfer pricing adjustments have been made by the Ld. TPO and confirmed by the Ld. CIT(A) which is tabulated as under:
Particulars Adjustment Upward adjustments in the transaction of : 6,37,22,701 1. Purchase of components for assembly 2. Purchase of fixed assets/tools 3. Sale of assembled goods
6.2. Ld. CIT(A) while dismissing the appeal of the assessee held that assessee had started with the wrong assumption that only three of the nine comparables would qualify as comparables. This has not been accepted in appeal. In the rest of the working, no defect was found by Ld. CIT(A) in the working employed by the TPO and the same was confirmed while series of assumptions employed by the assessee in its working were not accepted in the appeal. Accordingly, working of TPO remained undisturbed, as held by the Ld. CIT(A). Aggrieved by the upward TP adjustments confirmed by the Ld. CIT(A), assessee is in appeal before the Tribunal.
6.3. Before the Tribunal, assessee has placed on record, paper books in two volumes containing 1005 pages in total along with written submission, summary of the two grounds of appeal i.e. ground nos. 2 and 3 and relevant extracts of Rule 10B of the Income Tax Rules, 1963 (hereinafter referred to as the “Rules”) guidance note on transfer pricing
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regulations issued by Institute of Chartered Accountants of India (ICAI) as well as OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration.
6.4. Since Ld. Counsel has outrightly stated that she is pressing only on two grounds in respect of adjustment made for capacity utilization and status of working capital, the same are dealt hereunder.
In respect of capacity utilization adjustment, as already stated above, this being the first year of operation, assessee had significant idle capacity. A reference was made to audited financial statement of the assessee wherein licensed capacity, installed capacity and production details have been disclosed in the additional information pursuant to provisions of para 3 and 4 part II of Schedule VI to the Companies Act, 1956 in clause 12(a) placed at page 781 of the paper book. Details of the same are tabulated as under:
Licensed capacity, installed capacity and production:-
Item Unit License/installed capacity Production 2008-09 2007-08 2008-09 2007-08 Metal Bellows Pcs 60,000 60,000 12,385 10,693 Cupling Bellows Pcs 8,00,000 NA 1,89,166 NA
7.1. Capacity utilization levels of the comparables selected both by the assessee as well as Ld. TPO were analysed. Data relating to capacity utilization levels were available in respect of three such comparables in respect of set of comparables selected by the Ld. TPO. Data relating to capacity utilization level was available in respect of four comparables in respect of set of comparables selected by the assessee. Following are the details of comparables along with their average capital utilization levels:
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7.2. Based on this working, it was contended that comparables were operating at a much higher capacity per year than what the assessee operated at, during its first year of operation. Ld. Counsel submitted that assessee had utilized only 22% of its capacity whereas average capacity utilization of the comparable companies is at much higher level of 71% as tabulated above. These details were placed on record before the Ld. TPO and the Ld. CIT(A). Ld. TPO had computed Fixed Assets Turnover Ratio (FATR) to arrive at an understanding of the capacity levels of the comparables of the assessee and disregarded the workings in respect of the capacity utilization adjustment submitted by the assessee. While disregarding the working of capital utilization adjustment furnished by the assessee, Ld. TPO observed as under:
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“(i) Capacity Utilisation risk not taken into account in the T P Report ii) Independent companies do not charge at premium rate to account for underutilization of capacity. iii) Non reflection of differences in utilization of infrastructure on pricing of independent comparables. iv) No evidence or reliable report to show that comparable companies' prices change with their capacity utilization rates or margin changes because of under utilization. v) The taxpayer submitted capacity workings as per which idle capacity was computed at 77.86% and as a result abnormal loss of Rs 4,77,88,098 was calculated in the TP Report by the Appellant. However, on perusal of fixed assets schedule, it was concluded that the assets were put to use during the year and full depreciation was claimed. vi) Fixed Asset Turnover Ratio considered to compare the capacity utilization of the Appellant and the comparables; vii) It is important for a manufacturing firm that uses significant plant and equipment in its operation to calculate Fixed Asset Turnover Ratio. It was cited that if Fixed Turnover Ratio is low, it means that sale is low or investment in plant & machinery is too high. The firm having high Fixed Asset Turnover Ratio are likely operating in over capacity and the same should be curtailed by reducing the capacity or increasing its asset base to support its sales. As computation of fixed asset ratio is similar for both comparable companies and the Appellant, it was stated that the Appellant is operating at optimum label and thus rejected the contention of the Appellant. viii) The Average Net fixed assets ratio of comparables was calculated at 35.56%, whereas that of the Appellant at 51.98% by the learned TPO.”
7.3. On the application of FATR by the Ld. TPO, ld. Counsel submitted that this ratio is not a correct indicator to measure the capacity utilization of a company but it is a measure for its efficiency even though Ld. TPO has stated that FATR of the assessee is at optimum level and if the same is compared to the comparable companies. Ld. Counsel also pointed out that while computing the FATR, Ld. TPO has applied the formula in an incorrect manner, Ld. TPO has computed the FATR by keeping the turnover in the denominator and fixed assets in the numerator by which the aforesaid FATR of the comparable companies comes to 35.56% and that of the assessee comes to 51.98% which has led him to conclude that assessee is at optimum level when
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the same is compared with comparable companies. By pointing out to the correct application of the formula for computing FATR even though it is not correct indicator as per the Ld. Counsel of the assessee, the average FATR of the comparables is at 373.22% and that of the assessee is at 194.47% which evidently demonstrates that assessee is operating at lower level of capacity utilization than the comparables as the FATR of the comparables is at better level compared to the assessee. It was submitted that capacity utilization adjustment is done to eliminate material differences on account of difference in capacity utilization levels between the assessee and the comparables since under-utilization of capacity leads to under absorption of fixed costs, impacting the profits of the assessee adversely and need not affect the price. The price is impacted by entry strategy adopted by start-up entities irrespective of the capacity being utilized. It was thus contended that the observation of the Ld. CIT(A) to link capacity utilization levels with price is without any base. On the observation of Ld. CIT(A) that the entire machinery of the assessee has been put to use for manufacturing process resulting in full claim of depreciation, Ld. Counsel contended that depreciation figures used in the tax audit report are governed by tax laws and is not indicative of the production made by using the said machineries.
7.4. In relation to ground no. 3 in respect of working capital adjustment made by the assessee to eliminate material differences for comparability, it was submitted that assessee being in the start-up phase, was operating with much lower levels of accounts receivables and inventory and higher levels of accounts payables. This implied that assessee did not have enough short term assets to cover its short term debts. It was submitted that levels of working capital have an impact on the prices charged and consequently the profits earned by a company. It would be against TP regulations and guidelines to compare
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the profits earned without making an economic adjustment in relation to the differences in working capital levels. To explain the rationale of making working capital adjustment, it was submitted that a business organization needs funds to cover the time gap between the time it invests money i.e. payments to suppliers and the time to collect investments i.e. collection from customers. This time gap is calculated as the period required to sell the inventories to customers plus the time required for collection of money from customers less the period allowed by suppliers for payments. It was further submitted that in a competitive environment, money has time value and such differences arise due to difference in financial/commercial terms of purchase and sales as well as by difference in levels of inventory maintained. The operating profits get impacted by such differences due to the financing cost of the working capital structure. A comparable company with favourable working capital position would be better off in terms of low or negative interest costs resulting in better margins and vice versa. Ld. Counsel thus submitted that in order to align the difference in working capital levels between that of the assessee and the comparables, impugned adjustment towards working capital was undertaken. It was also pointed out that Ld. TPO did not perform the working capital adjustment on the comparables selected by him without providing any reason for the same. At the same time, Ld. TPO disregarded the adjustment undertaken by the assessee, which according to assessee is in consonance with Rule 10B(3) of the Rules. 7.5. Methodology of computing the working capital adjustment undertaken by the assessee is elaborated as under:
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Ld. Counsel referred to the regulations and guidelines of rule 10B(1)(e), 10B(2) and 10B(3) of the Rules as well as the Guidance Note on Transfer Pricing Regulations issued by ICAI by referring to point no. 6.44, 6.45, 6.53(a) and (e), 7.74. She also referred to the OECD transfer pricing guidelines, point no. 2.76 and Illustration 3 of Annex 1 to Chapter II and also Annex 2 Chapter III, by referring to example of capacity utilization and working capital adjustment. She also placed reliance on various judicial precedents wherein adjustments for capacity utilization and working capital levels have been held to be permissible adjustment.
Ld. Sr. DR referred to the order of Ld. TPO to point out the comparables selected by him and his observations on the capacity
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utilization adjustment stated in para 9. It was contended that through the use of FATR, Ld. TPO has considered, both the capacity utilization adjustment and working capital level adjustment together and such an application is not erroneous. It was also contended that the brand value of the AE of the assessee does not warrant any capacity utilization adjustment on the contention of the assessee that in the first year of operations in automotive sector, manufacture customer would not entrust significant volumes to a new vendor unless it is satisfied with a price and quality of the products supplied by the vendor.
We have heard the rival contentions and perused the material available on record and gone through the submissions made. Before embarking upon deciding the two issues before us, it is more appropriate to understand the relevant regulations and guidelines which need to be borne in mind. Rule 10B of the Rules deals with determination of arm’s length price u/s. 92C of the Act. MAM in the present case is TNMM which is not in dispute. We also note that assessee has been selected as the tested party which is also not in dispute.
10.1. The relevant extract from Rule 10B is as under: “(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 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;
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(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) any other method as provided in rule 10AB. ] (2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (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. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction [or a specified domestic transaction] shall be the data relating to the financial year [(hereafter in this rule and in rule 10CA referred to as the 'current year')] in which the international transaction [or the specified domestic transaction] has been entered into : Provided that data relating to a period not being more than two years prior to [the current year] may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared:
10.2. Useful reference is also made to the Guidance Note issued by ICAI on report u/s. 92E of the Act (revised 2020) which is as under:
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10.3. Reference is also made to the relevant extracts from Transfer Pricing Guidelines for Multinational Enterprises and tax Administrations issued by OECD:
From the above regulations and guidelines, we note that as per section 92C of the Act, ALP is required to be computed using any of the
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given six methods and in the manner as is prescribed in Rule 10B of the Rules. Rule 10B in turn states that the MAM would be one which, inter alia provides the most reliable measure of ALP and one of the important factors to be taken into account is the ability to make reliable and accurate adjustment. Reliability and accuracy of adjustment would largely depend on availability of reliable and accurate data. For certain types of adjustments, relevant data for comparables may either not to be available in public domain or may not be readily determinable based on information available in public domain. One has to resort to provisions of Rule 10B(3) which provides for making “reasonably accurate adjustments” for eliminating any material differences between the two transactions being compared since the purpose of comparability analysis is to examine as to whether or not, the values stated in the international transaction are at ALP.
From the above submissions and material placed on record, it is undisputed that assessee has utilized only 22% of its installed capacity in the year under consideration. It is also evident that the comparables are at higher levels of capacity utilization. These facts are incorporated in the tables reproduced above. We note that capacity utilization has a co-relation with the profits earned by a company since it leads to under-absorption of fixed cost, more particularly when the MAM selected is TNMM. Further, we note that FATR is not an indicator of capacity utilization of a company. In respect of working capital adjustment, we note that it is undisputed that assessee has a lower level of working capital as compared to the comparables. Admittedly, levels of working capital have an impact on the prices charged and the profits earned by a company. In respect of the above two adjustments, we note that it would be against the TP regulations and guidelines enumerated above to compare the profits earned without making these economic adjustments.
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From rule 10B(3)(ii) of the Rules, we note that an uncontrolled transaction is considered to be comparable if none of the differences are likely to materially affect the price or cost charged or the profit arising therefrom in the open market or if reasonable accurate adjustment can be made to eliminate the material effect of such differences, if they so exist. Thus, it is reasonable to infer from the said rule that the purpose or intent of the comparability analysis is to examine as to whether or not values stated for the international transactions are at arm’s length i.e. whether the price charged is comparable to the price charged under an uncontrolled transaction of similar nature. The position that emerges under the regulation is that if there are differences which can be adjusted, then adjustments are required to be made and also that if the differences between the companies are so material that adjustment is not possible then comparables are required to be rejected.
In the present case, assessee has given detailed working in respect of financial adjustments undertaken to eliminate material differences towards capacity utilization and working capital levels. On both the issues of differences towards capacity utilization and working capital levels, we find that it is a settled position of law whereby such an adjustment has to be granted. There are plethora of judicial precedents which have dealt with the two issues, permitting the adjustment for effective comparability. Certain relevant judicial precedence dealing with the two issues in hand as pressed by the Ld. Counsel are referred below along with the relevant extracts for better understanding of the subject matter.
IKA India (P.) ltd. v. Assistant Commissioner of Income Tax, Circle-3(1)(1), Bangalore (2019)101 taxmann.com 276
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“28. The reliability and accuracy of adjustments would largely depend an availability of reliable and accurate data. For certain types of adjustments, relevant data for comparable 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 sub-clause (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)] … 31. The assessee has under-utilized capacity during the subject AY and is accordingly factually and legally eligible to an adjustment for the same. Therefore, such a benefit cannot be denied to the assessee only for the reason that the data about comparable companies is not available. Requiring the assessee to produce such a data which is not available in public domain would tantamount to requiring the Appellant to perform an impossible task. The only way to get the data in the current case, would be where the TPO collates the same from the comparable companies by exercising his powers under section 133(6) of the Act. 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.' … The position in India as per Indian regulations on the subject has been noted earlier. If there are differences which can be adjusted, then adjustments are required to be made. If the difference between the companies are so material that adjustment is not possible, then comparables are required to be rejected." 40. In light of the principles embodied in the above judgment, the assessee prayed that the benefit of a working capital adjustment should be accorded to the assessee in the instant case. 41. The CIT(A) rejected the claim of the assessee for the reason the assessee has to demonstrate the impact on profit margins by reason of a particular level of working capital requirement in the case of the assessee and that of comparable companies. In coming to the above conclusion, the CIT(A) has
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placed reliance on decisions of Chennai ITAT in the case of Mobis India, ITA No.2112/Mds/2011 (AY 2007-08) and SAMDeutz Fahr India Pvt. Ltd., ITA No.2666/Mds/2016 AY 2006-07, order dated 22.2.2017. In those cases, the Tribunal was dealing with case where data was not provided. In the present case the assessee has given such working which is given as Annex. 4 to the written submissions filed before us. Such working was also given in pages 59 to 64 of submissions filed before the CIT(A) . Therefore, the TPO/AO is directed to consider the claim of the assessee and allow adjustment to profit margins towards working capital adjustment in accordance with the law, after affording assessee the opportunity of being heard. Gr.No.8 is decided accordingly.
15.1. Tasty Bite Eatables ltd. v. Assistant Commissioner of Income-tax, Circle-7, Pune ([2015) 59 taxmann.com 437)
“36. Respectfully following the above decisions cited (Supra) we are of the considered opinion that the assessee should be given the benefit of low capacity utilisation. We therefore restore the ground of appeal No.2 to the file of the AO/TPO with a direction to consider the appropriate adjustment after necessary verification on the basis of material supplied by the assessee. The Assessing Officer shall recompute such adjustment after giving due opportunity of being heard to the assessee.”
15.2. Pact Closure Systems (India) Private Limited v. The Income Tax Officer, Ward - 2(1)(1), Bengaluru [TS-414-ITAT-2021(Bang)-TP]
“The main grievance is the non-granting of the adjustment with regard to underutilized capacity. On this issue, we find that the settled law is that adjustment on account of capacity utilization has to be granted. In this regard, the TPO is bound to exercise its powers under section 133(6) of the Act and to collate the information on capacity details of comparable companies, such as actual capacity in units, installed capacity, breakup of affixed and variable cost, product wise segmental profitability (if any) and provide the assessee opportunity by sharing the details so obtained on the comparable companies. The Tribunal also held that if there is want of information / data, adjustment can be made to the tested party also. In this regard, reference may be made to the decision of the ITAT Bengaluru Bench in the case of Flint Group India Pvt. Ltd., IT(TP) No.3285/Bang/2018 dated 31.10.2019. We are of the view that in the given facts and circumstances of the case, it would be just and appropriate to set aside the impugned order on this issue and remand the issue to the AO / TPO to carry out the exercise of allowing adjustment on account of underutilized capacity. We also find that the assesssee's objection with regard to not allowing working capital adjustment has been rejected by the DRP but the DRP has given the direction to the TPO / AO to take the margins of the comparables by considering finance cost as non-operating in nature. In our view, the directions of the DRP cannot be regarded as substitute for not granting working capital adjustment and therefore we direct the AO / TPO to allow working capital adjustment.”
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15.3. Skoda Auto India Pvt Ltd Vs. Asstt. Commissioner of Income Tax [ITA No. 202/PN/07, AY 2003-04]- Pune ITAT
"17. …. It was then contended that there was a gross under utilization of capacity as a result of which profitability was affected. It was submitted that the appellant company had utilized only 37.19% of its capacity whereas average capacity utilization of comparable companies works out to 68.15% was thus contended before us that the computation of TNMM was vitiated mismatch as the comparison was without taking into account (a) multiple year data; (b) the results of Ford India Limited ond Generol Motors Limited; (c) adjustments on account of high level of import content of raw material, and (d) adjustments on account of lower capacity utilization .... " 19. One of the things which is clearly discernable from the facts of this case is that so for as the year be are us is concerned, which was incidentally first full year of appellant's a operations, the import content of the raw materials was as high at 98.55%. This is materially different from the import content of the raw material in the cases of the comparables selected by the revenue authorities…… As was observed by a coordinate bench of this Tribunal in the case of E Gain Communications (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….." The adjustments then the required to be made for functional differences. The other way of looking at the present situation is to accept that business models of the appellant company and comparable companies are the same and it is on account of initial stages of business that the unusual 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, therefore, deem it fit and proper to remit this matter to the file of the Transfer Pricing Officer for fresh adjudication in the light of our above observations and particularly dealing with the contention that the present year being first full year of operations, the appellant was forced to have higher import content in raw material as the manufacturing facilities, and vendor development, was not complete, as also dealing with the contention that the business model in this year of operation was fundamentally different from the business model of the comparable concerns."
15.4. Calsonic Kansel Matherson Products Ltd. v. Deputy Commissioner of Income-tax, Circle 5(2), New Delhi [2016] 72 taxmann.com 109 (Delhi - Trib.)
“11. We have considered the submissions of both the parties and have perused the record of the case. Ld. DRP in principle has accepted that adjustment on account of capacity utilization is to be allowed to appellant. However, in the absence of non- availability of item wise expenses, in the case of comparable companies, restricted the adjustment only to depreciation. In 'our opinion, this is not the correct approach because unutilized capacity has direct bearing on
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the operational profits of the company, because in initial years there is over- absorption affixed costs leading to losses. The fixed cost is not limited to depreciation only but there are other elements of fixed costs also. Therefore, proper adjustment has to be allowed to appellant. We, therefore, restore this issue to the file of ld. AO/ TPO to compute the quantum of capacity adjustment. The appellant is directed to provide necessary details in this regard. In the result, this ground is allowed for statistical purposes. 14. We have considered the submissions of both the parties. It is now well settled that in order to arrive at correct comparability criteria, it is necessary that the working capital employed by comparables vis a vis working capital employed by tested party has to be examined and necessary working capital adjustment has to be made in order to arrive at level playing field. We, therefore, restore this matter to the file of Ld. TPO to consider the working capital adjustment as claimed by appellant as per pages 313 to 315 of appeal set and allow the capital working adjustment, if so required. In the result, this ground is allowed for statistical purposes.” 15.5. Dover India (P.) Ltd. v. Deputy Commissioner of Income-tax, Circle 1(2), Pune [2017] 81 taxmann.com 245
"As per the appellant, since the manufacturing operations were in nascent stag and the appellant had incurred abnormal losses due to underutilization of capacity and other unabsorbed expenses, etc., the said capacity under utilization adjustment should be allowed. It was further reported by the management that once the economic conditions improve, then the sales would increase and the company would be able to earn normal profits on its operations. Since this was the first complete year of operation and the manufacturing unit was in the nascent stage, the appellant incurred losses and asked for aforesaid adjustments. 14. …. However, similar exercise carried out by the appellant during the year under consideration i.e. after selecting the TNMM method as the most appropriate method, the appellant had made adjustment on account of capacity under-utilization, while benchmarking its international transaction vis-a-vis the margins earned by the comparables, which was rejected by the TPO. We find merit in the claim of appellant as this was the first complete year of operation. Accordingly, the appellant is entitled to the adjustment on account of capacity under-utilization. The Pune Bench of Tribunal in Tasty Bite Eatables Ltd's case (supra) has already allowed similar adjustment and accordingly, we hold that the same is to be allowed in the hands of appellant. Accordingly, we delete the proposed addition on account of non-allowable adjustment for capacity under- utilization at RS.1.44 crores.”
15.6. Amdocs Business Services Pvt. ltd. Vs. Dy. Commissioner of Income-tax, Cir.1(1), Pune [ITA No. 1412/PN/ll]- Pune ITAT.
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"9. The next major point made out by the appellant is that this being the first full year of operation, the appellant had incurred certain expenditure which are start-up costs and cannot be fully recovered in the instant year itself, and such an expenditure has abnormally affected the profit margin. It is also canvassed that due to the start-up year the capacity utilization was not satisfactory, whereas its profitability has been benchmarked against 13 comparables which are established entities and have been set up over the years. The plea set-up by the appellant for economic adjustments on account of under capacity utilization and being in start up phase, is not same thing which is unreasonable an neither it is otiose to the mechanism of transfer pricing assessments. In fact, in principle, the plea of the appellant is in line with the decisions of the Tribunal in the case of Global Vanttedge P. Ltd v. DCIT in ITA Nos 2763-2764/Del/09 (Del); Brintons Carpets Asia (P) Ltd v. DCIT 139 TTJ 177; and, Skada Auto India P. Ltd. v. ACIT 122 TTJ 699. In our view, the matter requiring factual appreciation, the same is remanded back to the file of the Assessing Officer, who shall consider the propositions put forth by the appellant and allow appropriate economic adjustments on a reasonable basis."
15.7. Global Vanttedge P. Ltd Vs. DCIT [ITA Nos 2763-2764/Del/09 - AY 03-04, 04-05]- Delhi ITAT
"5.4.4 Proceeding to the next issue, regarding claim of appellant for giving suitable adjustment on account of idle capacity and that they were in start up phase, I have considered the submissions of the appellant and looking to the fact that the remaining comparables were established entities, accordingly adjustment needs to be made while doing the comparability analysis. Normally wherever an entity is established it always carried some surplus capacity vis- a-vis present/Projected business operations. Looking into the IT industries which were in booming stage I hold that a surplus capacity to the extent of 1/3rd of the existing capacity is treated as normal in this industry in anticipation of future growth in business. Hence an adjustment to the profitability of the comparables should be made to the extent of 33.33%. This is also in accordance with the provision of Rule 10B(2) which states that condition prevailing in the market in which the tested party and comparables operates have to be considered while judging comparability of an international transaction with an uncontrolled transaction."
15.9. Fiat India Pvt. Ltd. Vs. ACIT [2010-TII-30-ITAT-MUM-TP)- Mumbai ITAT
"8. ….. As rightly held by the Id. CIT(A), the said submission made by the appellant is sufficient to demonstrate that there was a material difference. In the facts of the appellant's case and that of the comparable cases in terms of capacity utilization as well as in other terms. Appropriate adjustments thus were required to be made to eliminate such differences and after having considered the relevant transfer pricing guidelines as well as transfer pricing regulations, it was held by the Id. ClT(A) that various adjustments made by the appellant were reasonable and accurate. He also held that the said material difference were arbitrarily ignored by the TPO while disallowing the appellant's
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claim such for adjustments and there being no proper reasons assigned by him for ignoring the said difference, the transfer pricing exercise done by him in the report was entirely futile. At the time of hearing before us, the Ld. DR has not been able to raise any material contention to rebut/controvert the observations/finding recorded by the Ld. ClT(A) in his impugned order to arrive at the said conclusion. He has simply relied on the report of the transfer pricing officer in support of the Revenue's case. However, as pointed out by the Ld. Counsel for the appellant from the copies of relevant reports, the TPO himself has allowed similar adjustments made by the appellant in the immediately proceeding years i.e. A. Y. 2002-03, 2003-04 as well as in the immediately succeeding years i.e. 2005-06 and 2006-07 wherein the facts involved were similar to that of the year under consideration i.e. A. Y. 2004-05. We, therefore, find no infirmity in the impugned order of the Ld. ClT(A) holding that the adjustments made by the appellant in TNMM analysis were reasonable and accurate and as reflected in the said analysis, international transactions made by the appellant company with its associated concerns during the year under consideration were at arms length requiring no adjustment/addition on this issue. The impugned order of the Id. ClT(A) on this issue is therefore upheld dismissing ground No.2 of Revenue's appeal."
Considering the factual position detailed above and the position of law as referred in judicial precedents stated above as well as under the regulations and guidelines quoted hereinabove, we agree with the contention of the Ld. Counsel for the assessee to permit making adjustment in respect of capacity utilization and working capital levels vis-à-vis the comparables based on the methodology adopted by it as reproduced hereinabove. However, in the course of hearing and also by way of written submission, Ld. Counsel has pressed upon only two grounds i.e. ground nos. 2 and 3(supra) which when taken up in juxtaposition with the finding given by Ld. CIT(A) in the last para of his order leads to the selection of comparables by Ld. TPO and computation of PLI thereof has undisturbed. As already stated in the above paragraphs, Ld. Counsel for the assessee pressed only on Ground No. 2 and 3 and did not make any submissions in respect of all the other grounds, the same are dismissed as such.
16.1. Working done by the assessee in respect of two above stated adjustments is based on three comparables out of those selected by the Ld. TPO and four comparables out of those selected by the assessee.
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Since the grounds taken by the assessee on the selection of comparables by the Ld. TPO is not pressed upon in the instant appeal and the categorical finding of the Ld. CIT(A) on the same holding the selection of comparables by Ld. TPO as undisturbed, we find it proper to direct the Ld. TPO/AO to consider the claim of adjustment in respect of capacity utilization and working capital levels so as to allow adjustment to the profit margin on comparables selected by him (TPO/AO), after affording the assessee reasonable opportunity of being heard.
16.2. In a situation where the data about comparable companies is not available for the purpose of allowing adjustments towards capacity utilization and working capital levels, the only way to get the data in a current case would be by Ld. TPO collecting the same from the comparable companies so selected by him by exercising his powers u/s 133(6) of the Act. For this proposition, reliance is placed on the decision of Coordinate bench of ITAT, Mumbai in the case of Kiara Jewellery Pvt. Ltd. in ITA No. 8109/Mum/2011 wherein the TPO/AO was directed to obtain the exact details on 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 on being heard."
Accordingly, we also direct the Ld. TPO to exercise powers u/s. 133(6) of the Act to call for information on capacity utilization and working capital levels of the selected comparable companies in those
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cases whose data is not available in public domain. After obtaining the information, the assessee be given an opportunity to put up its case by sharing details so obtained and accordingly grant the adjustment for capacity utilization and working capital levels. We thus, remit the matter back to the file of Ld. TPO/AO in terms of our above directions and thus the appeal of the assessee is partly allowed for statistical purposes.
In the result, the appeal of the assessee is allowed for statistical purposes.
Order pronounced in the Court on 22nd November, 2022.
Sd/- Sd/- (SANJAY GARG) (GIRISH AGRAWAL) JUDICIAL MEMBER ACCOUNTANT MEMBER Kolkata, Dated 22/11/2022 *JD. Sr. PS आदेश क� �ितिलिप अ�ेिषत/Copy of the Order forwarded to : 1. अपीलाथ� / The Appellant 2. ��यथ� / The Respondent संबंिधत आयकर आयु� / Concerned Pr. CIT 3. 4. आयकर आयु� अपील / The CIT(A)-22, Kolkata. ( ) 5. िवभागीय �ितिनिध अिधकरण अपीलीय आयकर कोलकाता/DR,ITAT, Kolkata, , , 6. गाड� फाईल /Guard file. आदेशानुसार/ BY ORDER, TRUE COPY Assistant Registrar आयकर अपीलीय अिधकरण ITAT, Kolkata