M/S CLOSURE SYSTEMS INTERNATIONAL INDIA PVT LTD ,BANGALORE vs. INCOME TAX OFFICER WARD-2(1)(1), BANGALORE

This is an appeal by the assessee against the final Order of Assessment dated 18.01.2017 passed by the ITO, Ward – 2(1)(1), Bengaluru, under section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (hereinafter called ‘the Act’), in relation to Assessment Year 2012-13.

Grounds 1 to 6 raised by the assessee are general in nature and does not call for any specific adjudication. Grounds 7 to 20 raised by the assessee is in relation to determination of Arm’s Length Price (ALP) in respect of international transaction entered into by the assessee with its Associated Enterprise (AE). The assessee is a company engaged in the business of IT(TP)A No.209/Bang/2015 Page 2 of 12 manufacture of plastic, closure capping system, capper closure system, etc. During the relevant previous year, the assessee operated in 3 segments viz., manufacturing, trading and services. It is not in dispute that the international transaction in the trading and services sector has been accepted by the TPO as at arm’s length. The dispute is only with regard to determination of ALP in respect of manufacturing carried out by the assessee.

The Transfer Pricing Officer (TPO) to whom the Assessing Officer (AO) made a reference u/s.92CA of the Act, however recomputed the PLI and arrived at OP/OC margin of -36.83%. The computation of margins by the TPO was as follows:

The TPO rejected the TP analysis of the assessee for the reason that the tax payer computed the 3 years average of data without using the current financial year data. The TPO thereafter adopted current year data and several other filters and arrived at a set of 37 comparable companies. The average arithmetic profit margin of those comparable companies was 7.84%. The TPO noticed that the assessee had claimed a sum of Rs.5,52,67,877/- as not part of the operating expenses due to underutilization of its capacity. The TPO rejected the claim of the assessee in this regard and he held that as per the law laid down by the ITAT, Delhi Bench, the Tribunal in the case of Class India Pvt. Ltd., (2016) 62 taxmann.com 173 (Delhi) wherein it was held that the profit margin of the assessee cannot be altered and it is only the profit margin of comparable companies that can be altered and since the details of the capacity utilisation of the comparable companies was not available and since the assessee was not able to establish that the comparable companies were operating at 100% capacity, the adjustment on account of capacity utilization cannot be allowed. The TPO thereafter proceeded to compute the ALP as follows:

Aggrieved by the draft Assessment Order dated 20.03.2016, wherein the addition of Rs.6,68,29,282 was suggested by the TPO on account of IT(TP)A No.209/Bang/2015 Page 5 of 12 determination of ALP, the Assessee preferred objections before the Dispute Resolution Panel (DRP). The DRP passed its directions dated 27.12.2016. The DRP upheld the rejection of TP documents of the assessee and the conclusion of the TPO regarding use of multiple year data. On the inclusion of the 7 comparables chosen by the assessee in its TP study, the DRP agreed with the conclusion of the TPO. The findings of the DRP in this regard were as follows:

Deccan Polypacks The Company is involved in the manufacturing of HDPE/PP Woven sacks/fabric, film covers, HMHDPE /LDPE bags, which is alternate packing medium in comparison with jute or 2 Gujarat Raffia Inds The company is mainly engaged in manufacturing of P.E.Tarpaulin, H.D.P.E/P.P Woven sacks & other fabrics. 3 Raj packaging Inds The Company is involved in the manufacturing and Ltd exporting of multilayer co-extruded plastic film and 1 flexible packaging material. 4 Duropack Ltd The company is involved in the manufacture of plastic packaging products. 5 Pearl Polymers Ltd The Company is involved in the manufacturing of PET bottles, jars and -containers. The Company manufactures technologically advanced packaging materials for special applications in food products, beverages, Pharmaceuticals and allied sectors. 6 Kanpur The company is involved in the manufacture of Plastipack plastic packaging goods.

Similarly, the conclusion of the DRP on the 37 comparable companies chosen by the TPO is contained in para 2.6 of the DRP’s order which reads as follows:

Hitech Plast Ltd. 9.37% Mean Margin (20.76 -. 3 6.92% Having considered the submissions, on examination of the functional profile of 34 companies, in respect of which the objection has been raised by the assessee, to end the dispute in this regard and directions issued in paragraph 2.10 of this order, we accept the assessee's contention that out of the 37 companies selected by the TPO, the above 3 companies are functionally

The assessee had objected to the TPO not granting working capital adjustment. The DRP, however, rejected the contention for the reasons given in para 2.7 of its order which reads as follows: ''Having considered the submissions, it is noticed by us that the TPO has considered the finance cost, in the case of the assessee company, as non-operating. In such circumstances, similar treatment to the comparables takes care of the differences of working capital. Therefore, in our view, no separate adjustment on account of working capital is required to be given. However, we direct the Assessing Officer to consider the margin of the comparables also considering the finance cost as non-operating in nature. The objection is disposed accordingly.”

With regard to capacity utilization adjustment not having been the Assessee gave the following details of its capacity utilization: Sales Actual Percentage unit Capacity of Capacity Financial ('000) (‘000) utilization Year [A] [B] [A/B] 2011-12 2,10,934 5,76,216 37%

The DRP did not agree with the submission of the Assessee and the DRP held that the assessee is merely contending that the capacity utilisation during the assessment year is 37%, without producing any details with regard to the fixed cost in respect of such adjustment needs to be given and also furnishing evidences to justify that such under-utilisation is not there in the case of the comparables. Accordingly, the above objection was rejected.

The assessee was using technology of the AE for its manufacturing operations for which it paid royalty to the AE. While computing ALP, the assessee aggregated the transaction of receipt of consideration for manufacturing from the AE and the transaction of payment of royalty by the assessee to its AE and determined the ALP adopting a combined approach. In other words, the assessee clubbed the transaction of manufacturing with the transaction of payment of royalty and adopted a combined approach of determining the ALP. The DRP upheld the action of the TPO in segregating the royalty transaction from the transaction of manufacturing and adopted Comparative Uncontrolled Price (CUP) method for determining ALP of the transaction of payment of royalty. Thereafter the DRP held that as per the technology licence agreement dated 27.09.2011 article 5.2 licencee has to reimburse cost excluding salaries incurred by the technical expert and personnel assigned by the licensor to the licencee premises to provide relevant technical assistance and services. According to the DRP, the IT(TP)A No.209/Bang/2015 Page 9 of 12 assessee did not file any evidence with regard to the cost incurred by the AE. The DRP therefore was of the view that the assessee failed to prove that expenses were incurred for the purpose of business of the assessee. The DRP thereafter directed to exclude the royalty payment from the cost under the TNMM method while determining ALP for the international transaction of manufacturing segment. The DRP also held that since the assessee did not produce evidence for reimbursement. The payment of royalty under section 37 also. The sum to be disallowed in this regard was quantified in this regard at a sum of Rs.79,50,790/-. This figure was subsequently rectified by an order dated 27.12.2016 by the DRP by adopting the correct amount of royalty which is Rs.45,94,003/-.

Another objection before the DRP was that the payment under the transfer pricing, regulations can be made only to the value of the international transactions whereas the TPO has made the adjustment even in respect of transaction with unrelated parties. On this objection, the DRP called for a remand report from the TPO and the DRP concluded as follows:

Aggrieved by the direction of the DRP, the assessee is in appeal before the Tribunal raising various grounds of appeal. After hearing the rival submissions, what we notice is that the proceedings before the DRP there was only 1 hearing. 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 fixed 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 IT(TP)A No.209/Bang/2015 Page 11 of 12 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. We also find that the question whether transaction of payment of royalty can be aggregated with the international transaction of manufacturing activity also requires afresh look in the light of the submissions made by the learned Counsel for the assessee that the royalty payment as to whether it is linked with the trading segment also has not been verified. With regard to the comparables adopted by the assessee in the TP study, it is seen that the DRP has not properly analysed the submissions of the assessee. The 7 comparable companies also are engaged in manufacturing of plastic goods. The DRP has made observation that the assessee is engaged in manufacturing of plastic closures, caps, etc., and therefore the 7 companies are not functionally comparables. There seems to be a contradiction in the order of the DRP. In these given facts and circumstances of the case, we deem it fit and proper that the issue with regard to determination of ALP should be remanded to the AO / TPO for determination afresh in the light of the observations made by us in this order. The AO / TPO shall decide the issue of determination of ALP in the manufacturing segment afresh after affording assessee opportunity of being heard. Accordingly, the order of the AO is set aside and the issue remanded to the AO / TPO.

In the result, appeal of the assessee is treated as allowed for statistical purposes.