ACIT, NEW DELHI vs. M/S. KEIHIN PANALFA LIMITED, NEW DELHI

against the final assessment order passed subsequent to the directions of the Ld. Dispute Resolution Panel – I, New Delhi for assessment year 2009-10 whereas ITA 1201/Del/2014 is the department’s cross appeal.

Amount in Segment Most Margin Arm’s (Rs.) Appropriate of KPL Length International Method i.e. Margin of Transactions Tested comparable Party companies Purchase of 612,011,927 Manufacturing raw material, segment parts and components TNMM Purchase of 72,057,386 (-) 9.06%- capital goods After Payment of 18,520,144 capacity technical (-) adjustment guidance fee 5.18% CUP/TNMM Payment of 7,015,486 Royalty Payment of 44,034,540 technical know-how fee Purchase of 224,150,577 Trading TNMM (-) (-) 10.14% traded goods segment 5.77% 2.1 The assessee has two business segments - manufacturing segment and trading segment and the segmental results have been accepted by the Transfer Pricing Officer (TPO) as well as the Ld. Dispute Resolution Panel (DRP). During, the course of transfer pricing proceedings, the TPO determined the Arms Length Price (ALP) of royalty and technical know-how fee at NIL by applying the benefit test.

Further, in respect of the manufacturing segment, the TPO, after accepting that there is need to allow capacity adjustment, rejected the assessee’s computation of capacity under- utilization adjustment in the comparables and made such adjustment in the assessee’s manufacturing segment on an ad hoc basis. Further, the TPO was of the view that the assessee had cherry picked the 4 comparable companies and hence proposed 6 more new comparable companies and computed the average Profit Level Indicator (PLI) by using the formula OP/sales of the 10 comparables at 8.86% as against the PLI of the assessee’s manufacturing segment at 1% (after capacity adjustments in the assessee’s manufacturing segment). Thus, the TPO proposed an adjustment of Rs. 55,011,908/- in respect of the assessee’s manufacturing segment.

2.2 In respect of the trading segment, the TPO rejected all the 4 comparables of the assessee and proposed 2 new companies as comparables and determined the average PLI (OP/Net sales) of 12.96% and consequently made an adjustment of Rs.39,544,739/- in respect of assessee’s trading segment.

2.3 Apart from the transfer pricing adjustments, the AO also made addition/disallowances in respect of excise duty payable, late deposit of Provident Fund dues, foreign exchange loss, provision for warranty as well as disallowance u/s 40A(2)(b) of the Income Tax Act, 1961 (hereinafter called “the Act”).

2.4 The assessee approached the Ld. DRP against the transfer pricing adjustments as well as on corporate tax related issues but the Ld. DRP affirmed the order of TPO, however allowing a partial relief by correcting the PLI of one of the comparables (namely Stanes Motors) and holding the foreign exchange fluctuation as non-operating item, thereby reducing the Transfer Pricing (TP) adjustment to Rs.31,683,128/-. Some relief was also granted in respect of the corporate tax related issues by deleting the disallowance made u/s 40A(2)(b) of the Act as well as deleting the addition in respect of warranty.

2.5 Aggrieved, the assessee as well as the department have now approached the ITAT and have raised the following grounds in their respective appeals-

ITA 1790/Del/2014 – Assessee’s Appeal

“1) The learned Assessing Officer has erred in law and on facts and circumstances of assessee’s case in making additions/disallowances of Rs. 16,18,54,179/- on wholly illegal, erroneous and untenable grounds.

TRANSFER PRICING GROUNDS 2) The order of assessment passed by Ld. AO at the instance of DRP u/s 143(3)/144C is bad in law. 3) The Ld TPO/DRP and consequently the AO have erred in law and on facts and in circumstances of the case in making arm's length adjustments of Rs. 6,95,70,1707- in respect of payments in nature of Royalty, Technical Know-how fee and technical guidance fee as under:

The TPO/DRP and consequently the AO has erred in law a) and on facts and in the circumstances of the case in erroneously determining the ALP of the transaction on account of payment of royalty to the AE at Nil as against Rs. 70,15,486/- paid by the assessee on the ground that no benefit has accrued to the assessee out of such payment.

The TPO/DRP and consequently the AO has erred in law b) and on facts and in the circumstances of the case in erroneously determining the ALP of the transaction on account of payment of technical know-how to the AE at Nil as against Rs. 4,40,34,540/- paid by the assessee under the nomenclature of Royalty by applying the benefit test.

The TPO and consequently the AO has grossly erred on c) facts and in the circumstances of the case in erroneously determining the ALP of the transaction on account of payment of technical guidance fee to the AE at Nil as against Rs. 1,85,20,144/- paid by the assessee, in their final order by applying the benefit test although the Ld DRP was intended to allow this fee.

The TPO/DRP and consequently the AO has erred in law d) and on facts and in the circumstances of the case in erroneously exceeding their jurisdiction by judging Royalty, technical know-how & technical guidance fee payments made by the assessee through a benefit test, which is not based on any of the statutory methods prescribed as per section 92C of the IT Act.

The Ld TPO/DRP has grossly erred in law in treating the e) ALP of technical know how fee- Rs. 4,30,34,540/- at NIL and the ALP of technical guidance fee paid at Rs. 1,85,20,144/- at NIL inspite of the fact that similar payments made in earlier years arising out of similar arrangements were held to be at ALP by the Ld DRP itself.

Without prejudice to above, the Ld AO has erred in law f) and on facts of the case in proposing a disallowance of 25% of royalty payment as capital expenditure.

4) The Ld TPO/DRP and consequently the AO has erred in law and on facts and in circumstances of the case in making arm's length adjustments of Rs. 5,50,11,908/- in respect of purchase of raw materials for its manufacturing segment from its associated enterprises by- not computing and allowing the capacity adjustments in a) the legal manner introducing six (6) new companies as comparables b)

5)The Ld TPO/DRP and consequently the AO has erred in law and on facts and in circumstances of the case in making arm's length adjustments of Rs. 3,16,83,1287- in respect of purchase of traded goods in its trading segment from its associated enterprises by- not considering the reasons and justification for loss a) under trading segment arbitrarily rejecting the comparables selected by the b) appellant choosing two new companies as comparables which are c) functionally different selecting a trader of petrol & diesel-United Motors, with d) assessee, who is trading in auto parts & components in its trading segment. comparing a manufacturer-Stanes Motor Parts Ltd. with e) the assessee in its trading segment.

6) The Ld TPO/DRP and consequently the AO has grossly erred in law and on facts and in circumstances of the case in initiating the penalty u/s. 271AA in respect of international transactions in the nature of purchase of parts & components, payment of royalty and purchase of fixed assets.

CORPORATE TAX GROUNDS 7) (a) That the DRP as well as the AO has erred in law and facts and circumstances of the case and made additions amounting to Rs. 4,07,348/- on account of alleged non- payment of central excise duty u/s 43 B of the Act.

(b) That the DRP as well as the AO have failed to appreciate that no disallowance could be made on account of outstanding MODVAT credit as the assessee had cleared the goods exceeding this amount in the subsequent year before filing the income tax return.

8)That the DRP and consequently the AO has erred in law and facts and circumstances of the case in disallowing the foreign exchange loss of Rs. 51,81,625/- by erroneously applying the provisions of section 43 A of Act.

9)That each ground is independent of and without prejudice to the other grounds raised herein.

10)That the penalty proceedings initiated by relying on Explanation 1 to Sec 271(l)(c) is on wholly illegal and untenable grounds since there was no concealment of any income nor submission of any inaccurate particulars of income, nor any default according to law by the assessee. 11) That the charging of interest u/s 234A, 234B and 234C is bad in law and is prayed not to be upheld.”

1. Whether on the facts and circumstances of the case & in law, the Ld. Members of DRP has erred in deleting the addition of Rs. 17,57,677/- made by the A.O. u/s 40A(2)(b)? 2. Whether on the facts and circumstances of the case & in law, the Ld. Members of DRP has erred in deleting the addition of Rs. 30,23,000/- on a/c of warranty expenses? 3. That the order of the DRP is erroneous and is not tenable on facts and in law.”

3.1.0 With respect to ground no. 3, it was submitted that this ground agitated the determination of ALP of royalty, technical know-how fee, technical guidance and training fee of Rs. 69,570,170/- at NIL by applying the benefit test. The Ld. AR submitted that the assessed had benchmarked the international transactions of payment of royalty, technical know-how fee and technical guidance fees under Comparable Uncontrolled Price (‘CUP’) method as primary method for justifying the royalty rate of 1.2% to 3% by comparing it with the ongoing industry rate and RBI approved rates as external CUP. It was further submitted that the assessee had also applied overall Transactional Net Margin Method (‘TNMM’) at entity level as the secondary method as the aforesaid transactions are closely linked to manufacturing segment. The Ld. AR submitted that the TPO held that the international transaction of royalty payment was not closely linked transaction and that further it could not be aggregated in the manufacturing segment to compute its arm’s length price under the TNMM and the TPO determined the ALP of the impugned transaction of Royalty and technical know-how fee at Nil by applying “benefit test” under the CUP method and made a TP adjustment of Rs. 51,050,026/-, which comprised of royalty of Rs. 7,015,486/- and technical know-how fee of Rs. 44,034,2540/- which was not even claimed as revenue expenditure but had been capitalized and the Ld. DRP confirmed the TP adjustment in relation to the aforesaid transaction.

3.1.1 With respect to ground no 3(c), pertaining to technical guidance fee of Rs. 18,520,144/- it was submitted by the Ld. AR that in the revised order passed by the TPO to give effect to the Ld. DRP’s directions, the TPO made additional adjustment on account of ALP of international transaction of payment of technical guidance fees amounting to Rs. 18,520,144/- which is bad in law since the same was not part of the TPO’s order and also no adjustment was proposed by the TPO in his order. Further, since no adjustment had been made by the TPO, the assessee had not filed any objection before the Ld. DRP as well. The Ld. AR reiterated that it is only in the order giving effect to Ld. DRP’s directions that the TPO proposed the additional adjustment of Rs. 18,520,144/- on account of technical guidance fee. The Ld. AR submitted that this additional and ad hoc adjustment of Rs. 18,520,144/- be quashed at the threshold itself for the reason that the technology and technical assistance of the AE was of great relevance in the assessee’s business.

3.1.2 The Ld. AR submitted that the Associated Enterprise (‘AE’) i.e. Keihin Corporation, Japan (‘Keihin Japan’) has been continuously performing research & development activities to bring special new products to the market. The products are being developed after immense research to suit the specific requirements of a global brand that has a policy of upgrading every 5 years of introduction of a model. It was further submitted that the technology provided by the AE because of its uniqueness is not available in the open market and it was also explained before the TPO/ Ld. DRP that the technology developed by the AE and used by the assessee is exclusively for the Honda Group, for manufacturing of air- conditioning systems for its automobiles. The Ld. AR argued that in the ever changing automobile industry, the assessee’s existence has been dependent on the never ending support and up-gradation by means of technical guidance, assistance and training by its Associated Enterprise. The Ld. AR emphasized that there has been a continuous flow of information, better systems and improved designs to the assessee as they are developed by the AE. The Ld. AR further submitted that the License Agreement between the assessee and the AE is approved by the Government of India (Ministry of Industry, Department of Industrial Policy & Promotion) and if there was no necessity or benefit that the agreement would have endowed on the assessee, the Government of India would not have given its approval for the same.

3.1.3 The Ld. AR also submitted that identical issue in relation to arm’s length nature of international transaction of royalty and allied payments has been settled in assessee’s favour in Assessment Year (AY) 2004-05 & AY 2005-06 by the Hon’ble Delhi High Court. The Ld. AR also submitted that the Delhi Bench of the ITAT in AY 2006-07, AY 2007-08 & AY 2008-09 in assessee’s own case upheld the arm’s length nature of royalty and allied payments and deleted the adjustment and further, the TPO had appreciated the findings of Hon’ble Delhi HC and the ITAT in earlier years and had made no adjustment on account of international transactions of payment of royalty, technical know-how fee and technical guidance fees in subsequent years viz. AY 2010-11, AY 2011- 12, AY 2012-13, AY 2013-14 and AY 2014-15. The Ld. AR also drew our attention to the copies of the relevant orders already placed on and forming part of the paper-book. The Ld. AR re- iterated that the adjustment on the issue of payment of royalty, technical know-how fee and technical guidance fees has been deleted by the ITAT/ Hon’ble HC in earlier years and there is no adjustment by the TPO in subsequent years.

3.1.4 It was further submitted by the Ld. AR that there is no change in the facts pertaining to the international transactions of payment of royalty, technical know-how fee and technical guidance fees in AY 2009-10 when compared to other years. Reliance was placed on the judgments of the various Hon’ble High Courts and the Hon’ble Supreme Court wherein it had been held that rule of consistency should be applied in settled issues where there is no change in facts and circumstances.

3.1.5 The Ld. AR submitted that the same license agreements pertaining to the impugned transactions are continuing since the earlier assessment years and are effective for AY 2009-10 as well. Our attention was drawn to the copy of the Licence Agreement placed at Pages 147-153 of the Paper Book. It was submitted that on the facts of the case and in law, no ALP adjustment is called for in respect of Rs. 69,570,170/-.

3.1.6 The Ld. AR further argued that the benefit-test was erroneously applied by the TPO and erroneously upheld by the Ld. DRP as the TPO/ Ld. DRP had stepped out of their jurisdictions to consider that there was no necessity to pay royalty and technical know-how fee for the technology received from the parent company. Reliance was placed on the judgment of the Hon’ble Delhi High Court in the case of CIT vs. EKL Appliances Ltd., reported in 2012-TII-01-HC-DEL-TP and order of ITAT Delhi Bench in the case of DCIT Vs. Lumax Industries Limited reported in 2013-TII-154-ITAT-DEL-TP which was subsequently approved by the Hon’ble Jurisdictional Delhi High Court. It was submitted that the TPO/ Ld. DRP had grossly erred in determining the ALP of royalty and technical know-how fee at NIL by applying the benefit test which, as upheld by the Hon’ble High Court, had no legal sanction as it is not one of the prescribed methods under the law. It was prayed that the approach of the TPO/ Ld. DRP of applying the benefit test be rejected and adjustment made on this account be directed to be deleted.

3.1.7 The Ld. AR further submitted that the adjustment / disallowance of technical know-how fee is wholly erroneous. It was submitted that technical know-how fee of Rs. 44,034,540/- (out of 1,050,026/-) had been capitalised by the assessee as intangibles and therefore, the disallowance of an item which has been capitalized by the assessee is wholly erroneous and against the accounting and legal principles. It was submitted that in addition to the ground that royalty and technical know-how fee are at ALP under transfer pricing provisions, the addition of technical know-how being a capital expenditure not debited to the P&L account of the assessee is highly erroneous.

3.2.0 With respect to the assessee’s ground No. 4 pertaining to adjustment of Rs. 55,011,908/- in the manufacturing segment with respect to the purchase of raw material from AEs, the Ld. AR submitted that during AY 2009- 10, the assessee had purchased raw materials, parts and components from its AE amounting to Rs. 61.20 crores. The assessee had carried out a detailed benchmarking analysis for justifying the ALP of the said transaction under the manufacturing segment by applying the TNM Method. The PLI used by the assessee was operating profit on sales and the assessee had determined PLI of (-) 5.18% and PLI of the comparables had been determined at (-) 9.06%, after carrying out the adjustment on account of capacity utilization. The Ld. AR submitted that the TPO has alleged that the assessee had cherry picked 4 out of 17 comparables that were arrived at based on qualitative filters, which, according to the TPO, were low profit making companies and, thus, the assessee’s approach was alleged to be biased. The Ld. AR further submitted that the TPO selected 6 additional comparables from the rejected comparables as given in the TP Study and determined the PLI of 10 comparables at 8.86% and thereafter recomputed the PLI of the assessee at 1% by carrying out certain adjustments in the expenses of the assessee and estimated an ad hoc 10% normal increase in few expenses of AY 2008-09 and worked out the expenses to be considered while working out the PLI of the assessee. This adjustment was confirmed by the Ld. DRP.

3.2.1 The Ld. AR submitted that the allegation of cherry- picking of the comparables was incorrect as the assessee had a thorough a “qualitative process” and the assessee had chosen those companies which manufactured products similar to those manufactured by it i.e. electrical equipment in the broad automotive sector. He drew our attention to the TP Study (Para 6.6.15 of the Paper Book Page 100) wherein the qualitative filters were explained and a detailed accept-reject matrix in Appendix E-III was given. The Ld. AR submitted that the rejection of the assessee’s search process, without providing any cogent reason, was against various judicial pronouncements. The Ld. AR placed reliance on a number of judicial precedents from the co-ordinate Benches of the ITAT in this regard.

3.2.2 On the issue of comparables selected by the TPO, the Ld. AR submitted that the TPO had selected 6 new comparables from the accept-reject matrix of the TP Study which were neither functionally similar to the assessee nor manufactured the same or similar products. Further, all such comparables deal mainly in the core auto-components while the assessee deals in non-core auto components. It was submitted that, as such, the 6 comparables cannot be compared with the assessee as they operate in a different segment of the industry. The Ld. AR drew our attention to the judgment of the Hon’ble Delhi High Court in the case of Rampgreen Solutions (P.) Ltd. vs. CIT reported in (2015) 377 ITR 533 (Delhi) wherein the Hon’ble Jurisdictional Delhi High Court laid down the principles of choosing comparables. It was submitted that the Hon’ble High Court had emphasized the importance of product and functional similarity in determining the appropriate comparables. The Ld. AR submitted that in this judgment, the Hon’ble Delhi High Court had made a distinction between a company providing Knowledge Process Outsourcing (KPO) Services and a Business Processing Outsourcing (BPO) Services and on a similar corollary, the distinction of high-end and low-end service providers is akin to the distinction of core and non-core auto components in auto- component industry for the purpose of benchmarking. The Ld. AR submitted that such differentiation of core and noncore auto components has also been recognized by the Government while formulating the Safe Harbor rules. Reference was made to Rule 1OTA of the Income Tax Rules, 1962 (‘the Rules’) i.e. Safe Harbour Rules for distinguishing between “core auto components” and “non-core auto components”. The Ld. AR emphasized that the government has also prescribed a different threshold for the both the core and non-core auto components wherein the Government has prescribed a threshold PLI of 12% in case of core auto component manufacturers, while on the other hand in case of non-core auto component manufacturers, a lower threshold PLI of 8.5% has been prescribed. It was submitted that, thus, the Government has also recognised the difference in the business dynamics between core and non-core sectors and, therefore, it can be safely submitted that core and non-core auto component companies cannot be compared as such. Reliance was placed on the order of ITAT Delhi Bench in the case of IHG IT Services (India) Pvt. Ltd. reported in TS-638-ITAT- 2017(DEL)-TP wherein reference has been made to safe harbour rules.

3.2.3 The Ld. AR advanced the following arguments against the comparables introduced by the TPO:

3.2.3.1 Clutch Auto Ltd. It was submitted that there was product dissimilarity as this company is engaged in manufacture of ceramic and cushioned organic clutches, components and spares for the automotive sector whereas the assessee is engaged in manufacture of automotive air conditioning units and air conditioning equipment which is a completely different product line than this company. It was submitted that this company produced core auto component and this company was functionally not similar. It was further submitted that the products of the assessee got outdated with the model of the vehicle. It was submitted that during AY 2009- 10, the assessee had written off stocks of out-dated/obsolete models for crores of rupees, whereas this company has developed and upgraded clutches with retro-flexibility on old models of popular trucks and buses and, therefore, its functions are not comparable to the assessee and should be rejected.

3.2.3.2 JMT Auto Ltd. It was submitted that there was product dissimilarity as this company is engaged in substantial manufacturing of engine products, gear components and axle components, which are not electrical components. It also manufactures excavator components, automotive lock sets, combination switches, cluster switches, heater control lever, panel assembly and door latches and other components, which are, though, electrical components; do not form substantial part of its production. It was also submitted that this company also fell into the category of core auto component. The Ld. AR further submitted that the segmental profitability for sales of electrical and nonelectrical components is not available and since the company substantially manufactures engine products, gear components and axle components, it should be rejected on the basis of product dissimilarity.

3.2.3.3 Mahindra Sona Ltd. With respect to this comparable also, the Ld. AR submitted that there was product dissimilarity. It was submitted that this company is engaged in manufacture of propeller shafts for heavy duty vehicles, trucks, and light commercial vehicles, passenger cars, three wheelers, earth moving equipment, and construction machinery, axles for multi utility vehicles and clutches for multi utility vehicles and passenger cars and, therefore, it should be rejected on the basis of product dissimilarity. It was further submitted that the segment classification for this company was ‘core auto component’.

3.2.3.4 Shivam Autotech Ltd. With respect to this comparable also, the Ld. AR submitted that there was product dissimilarity as this company manufactures and markets components for the auto sector to an Original Equipment Manufacturer (OEM). It was submitted that company’s current product offering includes different kinds of Gear Blanks, Spline Shafts, and Finished Gears & Plungers. It was further submitted that the segment classification for this company was ‘core auto component’.

3.2.3.5 Suprajit Engineering Ltd. With respect to this comparable, the Ld. AR submitted that there was product dissimilarity as this company manufactures exhaustive range of mechanical control cables for motorcycles, cars, commercial vehicles and various non-automotive cables, which forms almost 82% of the production. It also manufactures instructions, Speedo-meters and many other parts, which form a small portion of the production. The Ld. AR submitted that in absence of availability of segmental profitability for sales of electrical and non-electrical components, the comparable should be rejected on the basis of product dissimilarity. It was further submitted that the segment classification for this company was ‘core auto component’.

3.2.3.6 Wabco India Ltd. The Ld. AR submitted that there was product dissimilarity as this company is engaged in substantial manufacturing of brake systems including air compressors, actuation systems, control valves which are components forming a part of the brakes manufactured. Hence, it should be rejected on the basis of product dissimilarity. It was further submitted that the segment classification for this company was ‘core auto component’.

3.2.3.7 It was further submitted by the Ld. AR that all the companies chosen by the TPO are not only product-wise and functionally different but are also engaged in manufacturing of core auto components and thus, they would not be comparable with regard to the non-core auto components manufactured by the assessee. Reference was again made to Rule 10TA of the Rules i.e. Safe Harbour Rules for the distinction between “core auto components” and “non-core auto components”. It was prayed that these comparables be rejected in determining the ALP of the International transactions of the assessee in the manufacturing segment. Our attention was also drawn to pages 223 and 224 of the Paper wherein an analysis of the comparables chosen by the assessee would show that the comparables of the assesse are manufacturing non-core auto components similar to the assessee. Therefore, they have been accepted as comparables by the Ld. TPO Also.

3.2.4 With respect to ground no 4(c) regarding incorrect adjustment with respect to under-utilisation of capacity, it was submitted that during AY 2009-10, the installed capacity of the manufacturing segment of the assessee was enhanced by about 127% whereas the overall turnover in manufacturing segment had gone down by 50%. It was further submitted that, in spite of the robust increase of about 10% in the average selling price of the products sold the assessee incurred substantial losses due to lower capacity utilization and a substantial decrease in its Sales.

The Ld. AR submitted that the PLI of the assessee in its manufacturing segment during the year under review is (-)

5.18%. It was further submitted that as the assessee had expanded its installed capacity, this had a direct impact on its fixed costs, its semi-variable costs and its depreciation. The Ld. AR emphasized that where there is an expansion in capacity or a new company which sets up a manufacturing operation, it takes at least 2-3 years for such operations to stabilize and fructify and attain break-even point on the enhanced capacity and the profits start accruing to such companies only after the breakeven point is achieved. The Ld. AR submitted that the negative PLI of the assessee is not due to the pricing of the international transactions entered into with the AEs, but actually because of substantial increase in the local costs due to the reason of expansion of the installed capacity.

3.2.4.1 The Ld. AR submitted that the TPO had made an ad hoc and arbitrary computation of capacity adjustment. It was submitted that the TPO had recomputed the PLI of the assessee at 1% by carrying out certain adjustments in the expenses of the assessee whereas the assessee had claimed capacity adjustment and had given a detailed working about such adjustments which has even been reproduced by the TPO in his order. It was submitted that the TPO has categorically admitted the capacity adjustment and also noted that the results of the comparables were absurd. It was submitted that having made such observations, the TPO should have rejected probably all the comparables instead of proceeding to examine the ALP of the international transaction based on such comparables. The Ld. AR also highlighted the fact that the Ld. DRP approved the capacity adjustment in principle but thereafter, the TPO picked up few operating expenses namely, salary, power and fuel, rates and taxes, repairs of machinery and depreciation and compared these expenses with assessee’s own expenses for AY 2008-09 and has, thereafter, artificially worked out a capacity adjustment equivalent to Rs. 2.57 crores by estimating a 10% normal increase in these expenses and worked out the expenses to be considered while working out the PLI of the assessee. It was submitted that such an ad hoc approach does not carry any legal sanctity.

3.2.4.2 It was further submitted that the assessee had utilized its capacity to the extent of 23.64% of its installed capacity as against average of 76.9% of capacity utilization by the comparables and detailed working of capacity utilization of the tested party as well as that of each of the comparables had been filed with the TPO and also adjustment had been worked out in the TP study (placed at Paper Book - Pages 105 to 110). It was prayed that the same may be held to be the only way of carrying out adjustment on account of under-utilization of capacity and the addition made by the TPO/AO may kindly be deleted on his account.

3.4.3.3 Praying for adjustment of material differences between the assessee company and the comparable companies on account of lower capacity utilization, the Ld. AR further submitted that the comparable companies are operating at much higher capacity utilization levels vis-a-vis the assessee and, therefore, an adjustment for eliminating the material differences on account of the different levels of operations is quintessential to establish the level playing field. Reference was made to Rule 10B (3)(ii) of the Income Tax Rules, 1962 which mandates adjustment for material differences wherein it is prescribed that an uncontrolled transaction shall be comparable to an international transaction if reasonably accurate adjustments can be made to eliminate the material effects of such differences. The Ld. AR also submitted a list of judicial precedents favouring capacity utilization adjustment.

3.4.3.4 It was further submitted that the assessee has claimed an adjustment in the PLI of the comparable companies on account of addition in its installed capacity which it has expanded during AY 2009-10 within the meaning of Rule 10B(3). A chart/summary of increased capacity and the actual production in AY 2009-10 was also submitted which is as under:

InstalledCapacity (In units) ActualProduction (In units) Particulars AY2009-10 AY2008-9 Variation AY AY Variation 2009-10 2008-9 ACSub assy 150,00 66,000 15,084 43,822 -65.58% Engine 127.27% AC Sub assy 150,000 66,000 42,767 62,300 -31.35% frame HVACAssy 150,000 66,000 28,634 20,324 40.89% Manifold assy 150,000 66,000 43,552 60,205 -27.66% 3.4.3.5 The Ld. AR submitted that the installed capacity of the assessee has gone up by almost 127%, but at the same time there is also a steep fall in the utilized capacities and production of goods when compared with the previous year. In the two years there is adverse variation in almost all segments of production except HVAC assemblies. The Ld. AR further submitted that that there prevails a significant difference in respect of ‘the stages of operational activity’ of the tested party and the comparable companies, which is directly impacting the profitability covenants of overall transactions due to under absorption of fixed overheads and under-utilization of capacity. Thus, an adjustment is essential for eliminating such material differences. Reliance was placed on orders of ITAT Delhi Bench in the case of Frigoglass India Pvt. Ltd. Vs. ACIT reported in TS-500-ITAT-2016(DEL)-TP and Claas India Pvt. Ltd. Vs. DCIT reported in TS-371-ITAT-2015(DEL)-TP in this regard.

3.4.3.6 The Ld. AR submitted that adjustment on account of differences in capacity utilization is required to be made in the margins of comparables. The Ld. AR also submitted that the assessee had calculated the margins by taking the effect of capacity utilization in the comparable companies which is as per the chart at Paper Book Page 110. This chart is being reproduced here-in-under for a ready reference:

Margins of Tested party and Assessee’s

Comparables (after capacity utilization adjustment):

S. Company Name Capacity Margins (after No. utilized (%) capacity utilization adjustment) Tested Party Keihin Panalfa Ltd. 23.64 -5.18% Comparable Companies 1. Jay Ushin 83.47 -11.13% 2. Lumax Automotive 37.34 3.00% Systems Ltd. 3. Lumax Industries Ltd. 75.03 -12.67% 4. Subros Industries Ltd. 72.20 -15.44% Arithmetical Mean -9.06% 3.4.3.7 The Ld. AR submitted that in order to obtain comparability between the margins of the tested party and the comparable companies selected, an adjustment in the turnover and variable expenses of the comparable companies is to be performed. It was further submitted that without prejudice to the assessee’s claim that the 6 comparables selected by the TPO should be deleted, in case the comparables are retained as acceptable comparables, then adjustment on account of capacity utilization needs to be done. It was submitted that 4 out of 6 comparables viz. JMT Auto Ltd, Shivam Auto Tech Ltd, Suprajit Engineering Ltd and Wabco India Ltd do not have capacity utilization data available in the public domain and material differences could not be adjusted, and, therefore, they can’t be retained as comparables due to non-availability of data required for capacity adjustment. The Ld. AR further submitted that the computation of margins of 2 other companies by taking effect of capacity utilization adjustment is shown in the submission dated 19.11.2012 filed before the TPO (at Paper Book Page 234). The said chart is being reproduced for a ready reference:

Margins of Comparables (after capacity adjustment)

S.No. Company Capacity Margins (after Name Utilized (%) capacity utilization adjustment) 1. Clutch Auto Ltd. 53.69 -21.29% 2. Mahindra Sona Ltd. 66.76 5.48% 3. Jay Ushin 83.47 -11.13% 4. Lumax Automotive 37.34 3.00% Systems Ltd.

5. Lumax Industries 75.03 -12.67% Ltd.

3.4.3.9 The Ld. AR also submitted another chart depicting capacity adjustment in all the 6 comparables by applying the ratio of the order of the ITAT Delhi Bench in the case of Claas India Pvt. Ltd. vs. DCIT reported in TS-371-ITAT-2015 (Del)-TP.

The chart submitted by the Ld. AR is as under:

Margins of Comparables (after capacity utilization adjustment as

per the order of the ITAT in Claas India (supra):

3.5 Coming to Ground No. 5 challenging the adjustment of Rs. 31,683,128/- on account of purchase of finished goods in the trading segment, the Ld. AR submitted that during AY 2009-10, the assessee purchased had trading goods from its AE amounting to Rs. 224,150,577/- and applied TNMM to benchmark this transaction under the Trading segment. The assessee carried out a search process and selected 4 comparables whose average net margin worked out at -10.14% as against the assessee’s net margin of -5.77%. Thus, the transaction was treated at ALP. It was further submitted that the TPO disregarded the search process done by the assessee and proceeded to adjust the price of the traded goods imported whereby he selected 2 new comparables namely Stanes Motors and United Motors in the final set, working out the arm’s length margin at 12.96% and made a TP adjustment of Rs. 39,544,739/- in the Trading segment. It was further submitted that the Ld. DRP provided partial relief to the assessee by directing correction of margin of one of the comparable namely Stanes Motors, and by holding that foreign exchange fluctuation should be treated as a non-operating item for the tested party and comparables for the purpose of comparability. This resulted in decrease of assessee’s net margin to (-)4.59% and reduction of TP adjustment to Rs.31,683,128/- in the Trading segment. The Ld. AR further submitted that the Department is not in appeal on this issue.

3.5.1 With respect to incorrect rejection of the assessee’s comparables, it was submitted by the Ld. AR that the TPO rejected all 4 comparables of the assessee on the grounds of persistent losses, negative net-worth and functional dissimilarity.

It was submitted that in the case of 2 comparables, namely Renowned Auto Products Manufacturers Limited and Tractors Engineers Ltd., the TPO stated that these companies are functionally not similar to the assessee, and hence should be rejected, since these are all manufacturing companies. The assessee agrees to the findings of the TPO.

3.5.2 Further, with respect to Spectra Industries Ltd, it was submitted that Spectra Industries Limited, though initially selected by the assessee in the TP Study, was wrongly rejected by it during the assessment, considering it to be a manufacturing company. It was submitted that Spectra Industries is purely engaged in trading of auto components as is evident from its PLI working at Paper Book Pages l41-142 and it should be considered as a comparable to the assessee. Reliance was placed on the judgment of the Hon’ble Punjab & Haryana High Court on the judgment in the case of CIT-II vs. Quark Systems India (P.) Ltd. reported in (2011) 244 CTR 542 wherein the Hon’ble Punjab and Haryana High Court held that the assessee is not estopped from pointing out a mistake in the assessment though such mistake is the result of evidence adduced by the taxpayer. It was further submitted that the TPO has wrongly contended that Spectra Industries is making persistent losses and that there are declining sales. It was submitted that both the facts noted by the TPO are incorrect. Our attention was drawn to the profitability position of the Spectra Industries since 2003 till date and placed at Annexure-7. It was submitted that Spectra Industries is not incurring the persistent losses and although the sales have declined a bit but they increased in the subsequent years. It was submitted that company is functionally comparable of the assessee and cannot be rejected on the incorrect and arbitrary reasons provided by the TPO. It was further submitted that Rule 10B (2)(b) of Income-tax Rules prescribes the FAR comparability as the one of critical factor for comparability analysis and Spectra Industries being functionally comparable, ought to be accepted. Reliance was placed on the judgment of Hon’ble jurisdictional Delhi High Court in the case of Chryscapital Investment Advisors (India) (P.) Ltd. Vs. DCIT reported in (2015)

376 ITR 183 (Delhi) wherein the Hon’ble High Court upheld the importance of functional comparability for determination of ALP.

Reliance was also placed on numerous other judicial precedents wherein the ITAT and the Hon’ble High Court have laid emphasis on selection of comparables which are functionally comparable to the controlled transaction.

3.5.3 With respect to justification for losses under Trading segment and Incorrect Rejection of Johnson Control India Pvt. Ltd. by the TPO it was submitted by the Ld. AR that in the case of Johnson Control India Pvt. Ltd., the same should be accepted as a comparable, since it satisfies the product similarity as well as the functional similarity criteria with the assessee. It was submitted that the TPO has rejected the company due to negative net worth and consistence losses and has stated that the company had abnormal business conditions which might be intrinsic or extrinsic. It was further submitted that the same is the case with the assessee since it too faced abnormal business conditions due to extensive abnormal devaluation of the Indian Rupee against the Japanese Yen during AY 2009-10, causing losses in its trading division. It was further submitted that it is unjustified to say that the assessee’s losses are due to its imports not being at ALP, when a domestic company with no AE transactions is also incurring losses. It was prayed that this comparable to be retained for the purpose of benchmarking the assessee’s transactions in the trading segment. Reliance was placed on the order of ITAT Delhi Bench in the case of Philip Morris Services India SA vs. ADIT reported in TS-224-ITAT- 2017(DEL)-TP wherein the Delhi Bench of the ITAT upheld the inclusion of functionally similar comparable company despite having losses and negative trend in its economy.

3.5.4 With respect to the two new comparables selected by the TPO, the Ld. AR submitted that the TPO selected 2 new comparable companies in the final set, namely Stanes Motors Parts Limited (‘Stanes Motors’) and United Motors (India) Limited (‘United Motors’) for determination of the ALP of the impugned international transaction. It was submitted that United Motors is not comparable at all as the products are completely different. It was submitted that on analysis of financials of United Motors, it is apparently clear that it is dealing in purchase and sale of diesel and petrol and has income from retail business arrangement, and, therefore, it is functionally not similar to the assessee. Our attention was drawn to Note 21 of the Annual Report of United Motors placed at Paper Book Page 356 and it was submitted that this company is not engaged in trading of auto parts but was actually involved in trading of petrol and diesel; paints and varnish and oil and grease. The Ld. AR submitted United Motors chosen by the TPO is not appropriate and should be rejected from the final set and Stanes Motors, Spectra Industries Limited and Johnson Control India Pvt. Ltd could be considered in the final set of comparables whose average PLI would work out to (-7.16%) which is lower than the margin of the assessee i.e. (-), 4.59%, thus, warranting no adjustment on account of ALP of its international transactions in the Trading segment.

3.6 With respect to Ground No. 7 challenging addition u/s 43B on account of non-payment of excise duty payable and taking adjustment against MODVAT credit of Rs. 407,348/-, it was submitted that the issue is fully covered in favour of the assessee in its own cases by the Delhi Bench of the ITAT in AY 2006-07 and AY 2008-09 (at Paper Book Page 472 Para 5.4) and by the Ld. DRP in AY 2007-08. The Ld. AR submitted that the AO had disallowed a sum of Rs.407,348/- u/s.43B in respect of MODVAT Credit, which has been adjusted against the excise duty payable before the due date of filing of return, simply following the preceding year order and without considering the submissions of assessee filed vide reply dated 13.02.2013. It was submitted that identical issue was before the Delhi Bench of the ITAT in AY 2006-07 and AY 2008-09 in assessee’s own case and also before the Ld. DRP in AY 2007-08 which was decided in favour of the assessee. It was submitted that based on judicial consistency, considering no change in the facts and circumstances of the assessee, the said addition not be upheld being a fully covered matter.

3.7 With respect to Ground No 8 pertaining to disallowance of foreign exchange loss of Rs. 5,181,625/- u/s 28/37 claimed on purchase of imported machinery, it was submitted by the Ld. AR that the foreign exchange loss claimed on purchase of imported machinery was incurred for assessee’s bona fide business operations. It was submitted that the AO held that the exchange loss of Rs. 18,155,000/- includes notional loss of Rs. 5,181,625/- claimed on the value of machinery and, therefore, disallowable. It was submitted that the AO has erroneously contended that since as per section 43A of the Act, there is no actual payment, this loss shall not be allowable. The Ld. AR submitted that the machinery got damaged during the unloading on Indian port. The machinery was insured and the assessee had lodged claim with the insurance company. The assessee made payment to the party from whom the machinery was purchased after receiving the insurance claim. It was submitted that although exchange loss under section 43A is allowed on actual payment basis, however the facts of the assessee are different and as such section 43A would not be applicable. It was further submitted that the assessee had not utilized / put to use the machinery in its business as due to the damage, the machinery was not in a position to be used in the business. Since the assessee has not utilized the assets in business to run its business, therefore, the same would not be covered under the ambit of section 43A.

Further, such loss is not in the nature of capital loss as the machinery was not put to use. Thus, such loss has been incurred during the normal course of business and hence should be allowed as revenue loss u/s 37 of the Act. Reliance was placed on the judgment of the Hon’ble Delhi High Court in the case of Indo Rama Synthetics (I) Ltd. vs. CIT 1 reported in (2011) 333 ITR 18 (Delhi HC) wherein the Hon’ble jurisdictional

Delhi High Court held that when project was abandoned and no new asset came into existence, the various expenditure incurred on such projects cannot be treated as capital expenditure but allowable as revenue expenditure. Further reliance was placed on the judgment of the Hon’ble High Court in the case of CIT v.

Priya Village Roadshows Ltd. reported in (2011) 332 ITR 594

(Delhi) in this regard. It was submitted that the loss incurred by the assessee by the way of short insurance claim received or by reinstatement of foreign exchange payable has arisen in the normal course of operations, the impact of forex loss on machinery is wholly & exclusively for the purposes of assessee’s bona fide business operations and is allowable u/s 37 or u/s 28 of the Act.

“This is an appeal which has been filed by the Department against the order passed by the learned DRP, wherein the DRP had directed the AO not to bring to tax two of the additions which were proposed by the AO in his draft assessment order.

Although, the assessee has also filed an appeal against the order of the DRP, but there are no cross issues involved in the appeal, because the appeal filed by the assessee and the issues raised thereon are not common. Therefore, this appeal can be heard independent of assessee’s appeal. Accordingly, ground-wise submissions of the assessee are as under:-

Ground No. l: Addition of Rs.17,57,677/- deleted by the DRP- The AO has discussed this issue at page 5, para 4 of his order passed u/s 143/144. The AO has followed the order for A.Y. 2008-09 and has estimated 10% increase over the payment, which was made by the assessee in assessment year 2008-09 and estimated the value of services, which according to the AO the assessee should have incurred and disallowed the balance amount. During the year, the assessee had incurred an expense of Rs.56,38,160/- for making payment to Panalfa Automotive Pvt. Ltd. (formerly known as Panalfa Investments Pvt. Ltd.) for obtaining and utilizing a Business Center owned by the said company as against Rs.54,24,000/- paid in Assessment Year 2008-09. This issue has been cropping up since assessment year 2003-04 and it has been found, as a matter of fact, that the amount paid by the assessee cannot be said to be unreasonable or excessive by any standard and no disallowance can be made u/s 40A(2)(b).

It would be noted from Page 8 of the enclosed papers, which is the relevant pages extracted from the Balance Sheet of the assessee, that the Business Centre Charges paid by the assessee were Rs.54.24 lakhs as on 31st March, 2008 which were Rs.56.38 lakhs during the year under consideration. There was an increase of less than 5% in these charges as compared to the last year. However, the Assessing Officer estimated an increase of 10% while allowing the Business Centre Charges over the last year. Since the amount paid in 31st March, 2008 has been found to be justified and going by the Assessing Officer who allowed 10% increase during the year, there is no reason that any part of the amount could have been disallowed by the learned Assessing Officer, it is respectfully submitted.

The leaned DRP has discussed this issue in para 10.1 to 10.4 of its order at page 25. The learned DRP has followed the order of Hon’ble ITAT in assessee’s own case on this issue and has allowed relief by holding as follows: “The taxpayer has submitted that this issue has come up before the ITAT in the case of the taxpayer itself in Assessment Year 2003-04 (when it arose first) and stands decided in favour of the taxpayer by the ITAT vide order dated 27.02.2009 in vide para 7 to 12 of the order. It is submitted that the Department has accepted the order and no Appeal u/s 260A has been filed. It is, therefore, stated that being a matter of fact, necessary relief on this account shall be given. The Panel has examined the matter. The disallowance proposed by the AO is based upon the facts as are continuing from the earlier years. In the light of the decision of the ITAT in the taxpayer’s own case in AY 2003-04 and that Appeal u/s 260A has not been filed, the Panel is of the opinion that the proposed disallowance cannot be sustained. The AO is therefore, directed to exclude the said disallowance in final order.” Thus, it would be noticed that as correctly noted by the DRP, the issue has been accepted by the Department when it first time in Assessment Year 2003-04 by not filing an appeal to High Court u/s 260A of the Income Tax Act. Again in A. Y. 2004-05 and A. Y. 2005- 06 department did not file appeal to High Court on this issue, although other issues were litigated in High Court. Copy of order of Hon’ble Delhi High Court is being filed at Pages 20 to 29 of this synopsis. Hon’ble ITAT in A. Y. 2006-07 to A. Y. 2008-09 followed the findings of ITAT for A. y. 2004-05 and A. Y. 2005-06 on this issue (Page 17 of this synopsis). Since the arrangement and other circumstances and the law on this issue remains the same, it is respectfully submitted that no adverse view can be taken and the issue may be treated as covered by earlier order of ITAT in assessee’s own case and the department’s ground on this issue is required to be dismissed. This issue is covered by ITAT’s common order for AYs 2006-07, 2007-08 and 2008-09 in 4309/Del/2011 & 4937/Del/2012, vide paras 6 to 6.3. Copy of the said order is enclosed for ready reference at Pages 10 to 19 of this synopsis.

Ground No.2: Addition of Rs.30,23,000/- on account of Warranty expenses - The AO had proposed an addition of Rs.30,23,000/- on account of warranty provision, The learned DRP has discussed this issue in para 13.1 to 13.4 at pages 30 and 31 of its order. The leaned DRP in para 13.4 of its order had observed that assessee has been regularly making similar provision on a scientific and reasonable basis in earlier years, which have all been allowed year after year from A.Y. 2006-07 to 2008-09. Therefore, by following the judgment of the Hon’ble Supreme Court in the case of Rotork Controls India Pvt. Ltd. vs. CIT, 314 ITR 62 as also other judgments referred to at page 31 of DRP order, the proposed action of the AO in the draft assessment order has not been approved by the DRP. The learned DRP has held as under: “The arguments of the taxpayer have been considered by the Panel. It is seen from the annual account of the taxpayer that the provisions for warranties are regularly made by it. The balance outstanding of warranty as on 31st March, 2008 was Rs.l5,63,000/- and it was Rs.30,23,000/- as on 31st March, 2009. The taxpayer has provided actual amounts of Rs.7,35,000/- in Assessment Year 2006-07, Rs.27,23,000/-in Assessment Year 2007-08, Rs.18,45,430/- in Assessment Year 2008- 09 and Rs.41,88,919/- in Assessment Year 2009-

As in the case of the taxpayer, the provisions of warranty is consistently made on certain rational basis and has been allowed over a period of various years/. In the light of the ratio of the decisions mentioned above, the Panel is of the view that the action of the AO on this account is not in accordance with the provisions of the law. The AO shall therefore, exclude the same while passing the final order.” It would be seen from the Page 9 of the documents enclosed, which is the relevant pages extracted from the Balance Sheet of the assessee for the current year, that provision of warranty is being made year after year as would be noted from Note No.

It is submitted that the findings recorded by the DRP with regard to regular system of accounting being followed by the assessee year after year for making provision on a scientific basis, is a matter of fact that has been recorded by the DRP. Unless the same is proved to be perverse or factually incorrect, no default can be found in the order of DRP and the department’s ground of appeal on this issue also needs to be rejected.

It is, therefore, prayed that the departmental appeal may please be dismissed.”

5.1 In response to the arguments advanced by the Ld. AR, the Ld. Senior Departmental Representative (Sr. DR) submitted that there was no finding of fact recorded by the Ld. DRP with respect to “royalty” and, therefore, it cannot be said to be an issue covered in favour of the assessee as was being claimed by the Ld. AR. The Ld. Senior DR placed extensive reliance on the findings of the TPO in this regard and read out relevant portions from the TPO’s order in support of her contention that the ALP had been correctly determined at NIL by the lower authorities.

5.2 With respect to the assessee’s claim regarding adjustment to be allowed for capacity utilization, it was submitted by the Ld. Sr. DR that the assessee was indulging in cherry-picking of the comparables as the companies which were not comparable had already been excluded by applying the various filters and they were not included in the final set of filters.

5.3 With respect to the differentiation between core auto component companies and non-core auto component companies, the Ld. Sr. DR submitted that CUP had not been applied by the assessee and that further extensive research had been undertaken while selecting/rejecting the comparables. Reference was made to the findings of the TPO in this regard and it was submitted that the final set of comparables should not be disturbed.

5.4 With reference to the foreign exchange fluctuation loss, reliance was placed on the findings of the TPO.

5.5 The Ld. Sr. DR also placed on record written submissions with respect to both the assessee’s appeal as well as the department’s appeal.

5.4.1 The written submissions of the Ld. Sr. DR in respect of the assessee’s appeal are being reproduced here-in-under for a ready reference:

“Written submission in case of Kehin Panalfa Ltd. (ITA No.

1790/Del/2014 for the A.Y. 2009- 10 :

The written submission in respect to the submission/grounds of appeal filed by the appellant is given hereunder in the point-wise manner:-

Assessee Appeal:- i. Ground No.3 (points a-f):- Adjustment of Rs. 6,95,70,170/- in respect of payments in nature of Royalty, Technical know-how fee and technical guidance fee. The TPO/DRP was justified in his order by applying the benefit test on the payment for Royalty and fee for technical know-how. As payment of royalty is a class of transaction of its own, it requires separate analysis and cannot be aggregated with other transactions. This is more so when the royalty payment and other transactions are not closely linked and also when the royalty payment is not a significant part of the total cost of the assessee, which may have much bearing on the entity wide profitability. The reliance can be placed upon the following case laws that entity wide margins cannot be adopted and transaction by transaction approach has to be followed while determining the arm’s length price of an international transaction. In the case of M/s Abhishek Auto Industries Ltd (2010-TII- 54-ITAT-Del-TP) it is held that only International transactions are to be taken into account and not the enterprise level In the case of M/s Ankit Diamonds (2010-TII-67-ITAT-Mum- TP) it is held that under TNMM, ALP has to be determined on the profit realized from an International transaction and not at entity level.

In the case of M/s Birla Soft (India) Ltd (2011-TII-41-ITAT- Del-TP) the ITAT has held that segmental account, even if unaudited, can be considered if the income or the expenses have been properly allocated.

The ITAT in the case of M/s Chiron Behring Vaccines Pvt Ltd (2011-TII-30-ITAT- Mum-TP) has held that TNMM requires comparison of net margin realized from international transaction and not comparison of operating margin of the enterprise as a whole. According to the ITAT, transaction by transaction approach has to be adopted.

In the case of M/s EXXON MOBIL COMPANY INDIA PVT LTD (2011-TII-68-ITAT-MUM-TP) it is held that two different activities like research activity and activity of promoting the licensing of technology owned by the group (marketing activity) cannot be clubbed together. In the case of M/s Global Vantedge Pvt Ltd [2010-TIOL-24- ITAT-Del] it is held that Comparability is to be done at segmental level and not at entity level” Following decision in the case of Twinkle Diamond etc the ITAT, Mumbai in the case of M/s Golawla Diamonds (2010- TII-53-ITAT-Mum-TP) held that net margin realized from the transaction or class of transactions is to be compared and not entity level margin. In the case of M/s Marubeni India Pvt Ltd (2011-TII-36- ITAT-Del-(TP) it is held that the profit of a particular operation cannot be clubbed with the earning of any other revenue stream. In the case of M/s Ranbaxy India [299 ITR (AT)175(Del)] it was held that ideally ALP should be determined transaction by transaction. In the case of M/s SAP Labs India Pvt Ltd (2010-TII-44-ITAT- Bang-TP) the ITAT held that comparable with no segmental breakup/information is not to be considered . In the case of M/s Star Diamond Group (2011-TII-20-ITAT- Mum-TP) the ITAT held that ALP of the International transaction is only to be determined. Entity level profit margin cannot be taken. In the case of M/s Star India Pvt Ltd [2008-TIOL-426-ITAT- (Mum) it is held that each international transaction is to be examined separately and ALP should be determined accordingly and different activities cannot be clubbed and common ALP cannot be determined. In the case of M/s Starlite Pvt Ltd. [2010-TII-28-ITAT-Mum- TP] it is held that TNMM does not permit comparison at enterprise level profits, it requires comparison of net margin realized from an international transaction . In the case of SYMANTEC SOFTWARE SOLUTIONS PVT LTD (2011-TII-60-ITAT- MUM-TP) the ITAT has held that TNMM requires comparison of net margin realized from the international transaction and not enterprise level margin. In the case of M/s Technimount ICB Pvt Ltd (2011-TII-31- ITAT-Mum-TP) the ITAT has held that segmental results are to be considered and not the profit at entity level. In the cases of M/s Twinkle Diamond (2010-TII-09-ITAT- Mum-TP) and M/s Tez Diam (2009-TII-02-ITAT-Mum-TP) it is held that TNMM does not permit comparison enterprise level profits and that it requires comparison of net profit margin realized from an international transaction or aggregate of class of international transactions. In the case of M/s UCB India Pvt Ltd [317 ITR (AT) 292 (Mum)] it is held that Rule 10B(l)(e) refers to net profit realised from international transactions and not of enterprise as a whole. The assessee cannot justify its inability to evaluate its transaction on standalone basis on the ground that there is no statuary requirement to maintain segmental data. Entity level comparison not permissible when only 50% transactions were international transactions; ALP to be determined on segmental results only

In the case of M/s UE Trade Corporation (India) (2011-TII-04- ITAT-Del-TP) the AO had made the adjustment by applying CUP method on transaction by transaction basis. The ITAT upheld the AO’s approach of benchmarking on transaction by transaction basis. In the case of M/s Vedaris Technology the ITAT held that company with no segmental information and having major revenue from other activity cannot be taken as a comparable. The ITAT in the case of M/s Wockhardt Ltd (2010-TII- 46- ITAT-Mum-TP) held that TNMM requires comparison of net margin realized from International transaction or on aggregate of international transactions and not comparison of margins of enterprise as a whole. Under TNMM, it is the net margin realized from the international transactions which is to be analyzed and not the enterprise level earnings. Sub clause (i) of clause (e) of Rule 10B (1) of the Income Tax Rules, 1962 states:-

"(i) the net profit margin realized by the enterprise from an international transaction entered into within 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.”

In view of the above discussion, TNMM adopted by the taxpayer for benchmarking this transaction cannot be accepted. In fact, for such payment the most appropriate method is CUP method. The taxpayer should have benchmarked the transaction under CUP and for this purpose either internal CUP or external CUP should have been used. If the taxpayer felt that no such CUP was available then at least it should have benchmarked the transaction by following the well accepted valuation methods like income approach viz. Discounted Cash Flow method etc. which could be taken as a CUP.

Further, The assessee has also placed reliance on the limits set by RBI for payment of royalty. For this regard it can be said that as far as RBI is considered, it does not look into the arm’s length nature of Royalty. The approval given by RBI would not suffice as the arm’s length rate. In this regard, it is to be stated that the RBI does not fix the rate at which a domestic company can pay royalty. The RBI only regulates the flow of foreign currency. Due to the regulatory powers, the RBI’s approval is required for any payment of royalty to nonresident person. But, RBI does not see the arm’s length nature of royalty paid whether Indian company is dealing with its related or unrelated entities located outside India. Even within this regulation, the taxpayer has the discretion to pay any rate within the band and RBI does not limit the royalty rate. But, as per the RBI regulations, if any royalty rate is above the ceiling existing at that time, the approval of the Central Government is required. The view that RBI approval does not automatically determine the arm’s length nature of transactions is upheld in the case of COCA COLA INDIA INC Vs ASSISTANT COMMISSIONER OF INCOME TAX (2008-TIOL-658-HC-P&H-IT), by the Punjab & Haryana High Court and also in the case of Perot Systems TSI (India) Ltd Vs DCIT (2010- TIOL-51-ITAT-DEL) by the ITAT, Delhi.

\ \ 57 1201/Del/2014 (ii) Ground 4:- The AO/TPO erred on facts and in law in making arm’s length adjustment of Rs. 5,50,11,908/- in regard of purchase of raw materials for its manufacturing segment by not allowing capacity adjustment.

The assessee has contended that the company had incurred losses during the year due to under utilisation of optimum capacity.

For this we need to understand that in any product life cycle, at the stage of inception, a company has to face the effects of learning curve with abnormal material wastage, incur huge costs on training the employees, under-utilisation of capacity due to low market share etc. Therefore, the fixed cost to the extent of capacity unutilised by the company are adjusted to arrive at the operating margin of the company. In this regard, reliance is placed on the following OECD Guidelines:

Para 1.35: "....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: "...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."

Para 1.60: ".... a taxpayer seeking to enter a new market or expand its market share might temporarily incur higher costs (e.g. due to start-up costs or increased marketing efforts) and hence achieve lower profit levels than other taxpayers operating in the same market.”

Para 1.70: "...associated enterprises, like independent enterprises, can sustain genuine losses, whether due to heavy start-up costs, unfavorable economic conditions, inefficiencies, or other legitimate business reasons..."

Before discussing the merits of the adjustment, it is important to note the provisions of law relating to grant of adjustment. As per the provisions of rule 10B (3),the comparability of the uncontrolled comparable transactions is to be considered only if there are no differences between the two. In case there are certain differences, the adjustments may be carried out to eliminate those differences but the adjustments are required to be "reasonably accurate". The relevant portion is reproduced below:

"(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."

Further perusal of the law relating to the application of TNMM is as reproduced below:

"10B(1)...

(e)transactional net margin method, by which,— (i)the net profit margin realised by the enterprise from an international transaction 55c[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; (iv)the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in subclause (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];"

A combined reading of both the provisions makes it amply clear that for the application of comparability adjustments in TNMM, the adjustments are required to be carried out in the financials of the comparables which should be reasonably accurate. A pre requisite for achieving a reasonable accuracy is the availability of reliable data, which could be utilised to arrive at proper conclusion. At this juncture, it is pertinent to mention that the assessee is required to maintain documentary evidence in respect of the determination of arms length price carried out by it and consequently it is required to maintain documentation in respect of such comparability adjustments also. It is further clear from the provisions of rule 10D(l)(k),as reproduced below:

"10D (1) Every person who has entered into an international transaction [or a specified domestic transaction] shall keep and maintain the following information and documents, namely:— (k) the assumptions, policies and price negotiations, if any, which have critically affected the determination of the arm's length price;

(m) any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of the arm's length price."

Similarly the assessee has also not provided any documentary basis for the assumptions taken into account for arriving at the adjustment figures for fixed cost or capacity utilisation or freight cost adjustment. The freight cost is part of normal business expenditure of any manufacturing business, and cannot be treated as an extraordinary business expense.

Without prejudice, it is again submitted that as per the provisions of law the adjustments are to be carried out in the case of comparables and not in the financials of the tested party. Further, unless specific details of the abnormal factors in the case of comparables are known, no adjustment can be carried out. The issue of comparability adjustment was examined by the Hon’ble tribunal in the case of Haworth (India) Pvt Ltd Vs. DCIT(2011) Taxmann.com 76(Delhi). The relevant portion of the judgment is reproduced below for convenience:

"Further, assessee had computed its margin after claiming adjustment on capacity utilization. Therefore, the first issue to be decided was that whether assessee could deviate from the net profit shown in its books of account for the purpose of computing arm's length price. The method adopted by the assessee was TNMM for the purpose of computing arm's length price. [Para 83] The expression 'net profit margin realized' means the net profit margin actually realized and actual cost incurred and sale effected and thus, there is no room for any assumption for taking the profit margin which has been realized. In the case of the tested party (assessee), it is not permissible to deviate from the book results on the ground of capacity utilization. The adjustment on account of capacity utilization, if any, is permissible by rule 10B(3)(\\) of the Income-tax Rules, 1962. [Para 84] Therefore, it is clear that in the case of tested party (assessee) there cannot be any deviation in the net profit shown in the books of account and the adjustment, if any can be made to the same to eliminate the material affects to such differences to the extent of these adjustments are reasonably accurate. Therefore, the position emerges is that adjustment can be granted to the assessee in computation of mean margin only to the extent of these being reasonably accurate. In the light of these provisions it was necessary to examine that whether or not department was right in rejecting the claim of assessee regarding capacity utilization. [Para 85] It was the submission of the assessee that it had assumed the capacity utilization of comparables to be 70 per cent in accordance with rule 10D(l)(k) in its TP study report due to unavailability of required details at that point of time and had also made appropriate disclosure therein. [Para 86] The perusal of rule 10D(1)(k ) will reveal that every person who is entered into an international transaction is under an obligation to keep and maintain the information and document with respect to the assumptions, policies and price negotiations, if any, which have critically affected the determination of the arm's length price. The TPO in its report had observed that assessee did not submit any evidence for assuming the capacity utilization of the comparables and whatever data relied upon by the assessee for seeking capacity utilization adjustment was either unreliable or incorrect. When fixed cost itself was incurred only for a part of the year the same could not be adjusted for differential capacity utilization. [Para 88] 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 per cent 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 these documents relied upon by assessee described the capacity utilization by the comparables. Thus, it was wrongly claimed by the assessee that it had furnished sufficient evidence with regard to capacity utilization in the cases of comparables. No credible information had been submitted by the assessee to seek adjustment on account of capacity utilization. Thus, it was to be held that assessee had not been able to furnish credible and accurate information with regard to capacity utilization and such 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]"

It is also important to reproduce the relevant OECD guidelines in this regard:

"A.6.2 Purpose of comparability adjustments 3.50 Comparability adjustments should be considered if [and only if] they are expected to increase the reliability of the results. Relevant considerations in this regard include the materiality of the difference for which an adjustment is being considered, the quality of the data subject to adjustment, the purpose of the adjustment and the reliability of the approach used to make the adjustment."

It can be observed that the purpose of the comparability adjustments is stated to be the increasing reliability of the results. The reliability of the results would again depend upon the quality of the data and their reliability of the approach used to make adjustment.

In this regard, notice may be taken of the decision of Delhi ITAT in the case of DCIT vs. Panasonic AVC Networks India Co Ltd (ITAT Delhi) (I.T.A. No.4620/Del/2011) who vide their order dated 21st Feb 2014 have held that capacity adjustment is allowable but the adjustment mechanism should be reasonable.

The relevant part of the judgment is reproduced below:

"4. So far as first ground of appeal is concerned, the issue in appeal lies in a very narrow compass of material facts. The taxpayer is engaged in the business of manufacturing and sale of colour television sets. During the course of assessment proceedings, the international transactions entered into by the taxpayer with its AEs were referred to the Transfer Pricing Officer for determination of arm’s length price. The taxpayer had used the TNMM with net profit margin on sales as profit level indicator. While this method was accepted by the TPO as well, one of the issues on which TPO did not agree with the taxpayer was adjustments for capacity utilization. The TPO rejected the taxpayer's claim for capacity utilization on the ground that, "all the comparables are also operating in same economic environment and all are playing same game of price cutting and volume generation" and "therefore, any adjustment on account of these two factors (i.e. capacity adjustment and risk adjustment) will change the level playing field and benchmarking of international transaction will not be correct reflection of economic activities undertaken by the taxpayer". The taxpayer was not satisfied with the stand so taken by the TPO and the matter was carried in appeal before the CIT (A). Learned CIT (A took note of taxpayer’s submission that the taxpayer's production in the relevant previous year was much below the installed capacity, that such capacity underutilization explained higher fixed costs and lower profits, and that the taxpayer's brands, i.e. 'National' and 'Panasonic', were premium brands with high end prices whereas

Indian television market was dominated by certain Korean brands which were producing high volumes on the basis of low profits. Learned CIT(A) was of the view that in case a reasonably accurate method of making adjustment for such low capacity utilization can indeed be made, such an adjustment will meet ends of justice particularly as the taxpayer had utilized only 31.75% of its installed capacity. Learned CIT (A) also noted that the details of installed capacity and utilized capacity are available in the financial statements of the companies, and is in public domain. It was in this backdrop that he directed the capacity underutilization adjustment in depreciation allowance, by making adjustments in depreciation figures of the tested party as also of the comparables, as the figures of depreciation as also of capacity utilization were available in respect of the comparables. It was also directed that in the case of companies with multi product profile, weighted average of capacity utilized for each product, using per unit sale price as weight, be used to compute the capacity utilized. Revenue is aggrieved of the directions so given by the CIT (A) and is in appeal before us. Having heard the rival contentions and having perused the material on record, we see no reasons to interfere in very well reasoned findings and directions of the learned CIT (A). Rule 10 B (l)(e)(ii) of the Income Tax Rules 1962 does indeed provide that the net profit margin realized in a comparable uncontrolled transaction is adjusted, inter alia, for differences in enterprise entering into such transactions, which could materially affect the net profit margin in open market. 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. In our considered view, the learned CIT (A)'s approach is reasonable in this regard and the adjustments are on a conceptually sound basis. In any case, as pointed out by the learned counsel, the adjustments so directed by the learned C1T(A) have duly been made by the Assessing Officer, and there have been no issues regarding implementing these adjustments. We approve the conclusions arrived by the CIT (A) on this issue and decline to interfere in the matter." In the light of above discussion and the fact that the assessee has not been able to substantiate its claims with credible and reliable data, no adjustment claim is allowed. Consequently, the capacity utilisation adjustment as sought by the assessee does not qualify the test of being "reasonably accurate" and is therefore denied. The margins of the comparables thus would be taken at the updated level for a single year without adjustment as furnished on record.

5.4.2 The written submissions of the Ld. Sr. DR in respect of the department’s appeal are being reproduced here-in-under for a ready reference:

“Written submission in case of Kehin Panalfa Ltd. ( A.Y. 2009- 10 The written submission in respect to the additional grounds of appeal filed by the revenue is given hereunder:

Department Appeal:- i. Ground No. 1: Foreign Exchange Fluctuation Loss not to be treated as non-operating Expenses

The DRP has in his order stated that the facts and circumstances of the case and in law and Ld. Member of DRP has erred in allowing relief of Rs. 7853611/- to the assessee while computing ALP in respect of "purchase of Finished Goods” by holding that foreign exchange fluctuation loss should be treated as non-operating expenses for the assessee and comparables.

The additional grounds of appeal filed in the case as directed by the Pr. Commissioner of income Tax Delhi-5 is to consider foreign exchange loss as operating in nature.

It can be noted that the above loss has directly resulted from trading items and the fact that forex gain/loss has been held as operating revenue/expenses by the Hon'ble Court in case of Ameriprise India (P) Ltd. Vs Assistant Commissioner of Income-tax, Circle-l(l), New Delhi [2015] 62 taxmann.com 237 (Delhi-Trib.). As also being the only grounds of appeal filed by the revenue. Further reliance supporting the above view can be referred from following cases as adjudicated by various Hon’ble Courts of India. (i) In the case of M/s S. Narendra. [ITA No. 6839/Mum/2012] it is held that foreign exchange fluctuation should form part of operating income/cost while computing operating margin. (ii) In the case of M/s Sap Labs India Private Ltd. (2010) 6 ITR 81) the Bangalore bench of Hon’ble ITAT has held that foreign exchange fluctuation fluctuation should form part of operating income/cost while computing operating margin. (iii) In the case of M/s CSR India Pvt.Ltd. IT(TP)A No.119/Bang/2011, the Bangalore bench of Hon’ble ITAT has held that foreign exchange fluctuation fluctuation should form part of operating income/cost while computing operating margin. (iv) In the case of Cash Edge India (Pvt.) Ltd [TS-443-ITAT- 2015(DEL)-TP]/ITA No.64/Del./2015, the coordinate bench held that the foreign exchange fluctuation should form part of operating expenses.

(v) In the case of M/s Westfalia Separator India Pvt. Ltd. the coordinate bench that foreign exchange fluctuation fluctuation should form part of operating income/cost while computing operating margin.

(vi) The special bench in case of ACIT vs. Prakash I. Shah (2008) 115 ITD 167 (Mum) SB, has held that foreign exchange fluctuation is a part of export turnover.

(vii) The Hon'ble Supreme Court in Sutlej Cotton Mills Ltd. VS. CIT 116 ITR 1 (SC) held that "where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business."

Corporate Grounds

The AO in its order stated that the assessee paid a sum of Rs. 56,38,160/- to M/s Panalfa Automative Pvt. Ltd. towards business centre charges. M/s Panalfa Automative Pvt. Ltd. is one of the persons specified u/s 40A(2)(b) of the Income Tax Act. The reasonableness of the amount paid vis-a-vis services/facilities has been examined. During the assessment proceedings for the year, the AO assessed the fair market value of services availed by the company at Rs. 35,27,712/- further a 10% benefit keeping in mind the inflation prices was also given to the assessee. The total amount was assessed at Rs. 38,80,483/-. Thus the difference amounting to Rs. 17,57,677/- was found to be excessive and unreasonable with regard to provisions of 40A(2)(b). Therefore, the amount being over and above the assessed cost shall not be allowed to be deducted as expenditure.

2. The Ld. Members of DRP erred in deleting the addition of Rs. 30.23.000/- on account of Warranty expenses:

The AO in its order stated that the assessee company has debited an amount of Rs. 41,88,919/- on account of warranty expenses. Further, on point 18 to notes of accounts annexed with the Balance Sheet, the statutory auditor has mentioned that at the end of the year under consideration, the warranty expenses of Rs. 30,23,000/- were unexhausted and therefore, the same were provisional in nature and any expenditure which is provisional in nature is not allowable as deduction as per the Act.

It is further noted that the assessee failed to furnish any proper explanation regarding the rationale of warranty expenses relating to total sales of the year. The decisions of various courts make it clear that an ad hoc basis for deciding the amount of warranty expenditure cannot be allowed.

Reliance is placed on the following case.

In Senthilkumara Nadar & Sons vs. CIT (1957) 32 ITR 138 (Mad) this Court held that,

"It should be taken as well settled now that without statutory warrant - and there is none in s. 10(2) (xv) - deductions are not permissible for anticipated losses, even if they are inevitable nor for contingent liabilities."

6. In rejoinder, the Ld. AR reiterated the submissions made earlier with respect to assessee’s appeal and placed extensive reliance on the findings of the Ld. DRP with respect to the Department’s appeal.

“5.11 Facts and circumstances of this TP adjustments are similar to AY 2004 – 05. Ld. CIT (A) has also substantially relied on the order for AY 2005 – 06 while granting the relief.

Ld. CIT (A) has supplemented his order on the necessity of paying the royalty which is to be decided from businessmen point of view. This proposition has been upheld by the Hon’ble Delhi High Court in the case of CIT versus EKL Appliances – 2012 – TII – 01 – HC – DEL-TP. The accepted history of the case regarding payment of royalty is that in assessment year 2003 – 04 also the matter travelled up to the High Court. It is held in favour of the assessee that the payment of running royalty is on revenue account. Therefore, in view of the Hon’ble Delhi High Court judgment in assessee’s own case the necessity of royalty cannot be questioned or doubted.

5.12 Besides similar issue of royalty payment is decided in favour of the assessee is decided by the ITAT in the case of Lumax Industries Ltd – 2013 – TII – 123 – ITAT – DEL – TP holding that –

“Payment of royalty was being claimed and allowed right from 1984 to assessment year 2003 – 04, as business expenditure of the assessee and no new circumstance has been pointed out by either of the authorities below to hold that in the years there after, the benefit accrued to the assessee by the payment of such royalty has dried up.”

5.13 Our aforesaid view is fortified by the aforesaid judgment of Lumax Industries (supra). Since the royalty was being paid from 1997 and was continuously examined by the AO, then in the absence of any new facts to hold that there was no need to pay the royalty was uncalled for.

5.14 After hearing the parties and on producer of the record in our considered view no interference is called for in the order passed by the CIT (A) on this issue and the appeal of the revenue for AY 2005 – 06 is dismissed”

7.1.1 We also note that no adjustment on account of international transactions with regard to payment of royalty, technical know-how fee and technical guidance fees in subsequent assessment years 2010 – 11, 2011 – 12, 2012 – 13, 2013 – 14 and 2014 – 15 have been made by the TPO. We also note that there is no change in the facts pertaining to the international transactions for the payment of royalty, technical know-how fee and technical guidance fees in the year under consideration when compared with other assessment years. We also note that the royalty payments have been made under the same license agreement under which payments had been made for earlier years. Thus, there is no change in the facts and circumstances under which the impugned payments have been made. Although, the TPO has applied the benefit test to hold that there was no necessity to pay royalty and technical know-how fee for the technology received from the parent company and the Ld. DRP has also upheld this finding of the TPO, we are of the considered opinion that both the authorities below have exceeded their jurisdiction in coming to this finding. Reliance is placed on the judgment of the Hon’ble Delhi High Court in the case of CIT versus EKL Appliances Ltd (supra) wherein it has been held by the Hon’ble Delhi High Court that Rule 10B (1) (a) of the Act does not authorise the disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or in view of the continuous losses suffered by the assessee in the business or that he could have fared better had he not incurred such expenditure. The Hon’ble Delhi High Court went on to hold that these are irrelevant considerations for the purpose of Rule 10B. The Hon’ble Delhi High Court held that it was for the assessee to decide whether or not to enter into the transaction. The Hon’ble Delhi High Court further held that the revenue authorities can only decide the quantum of expenditure but they have no authority to disallow the entire expenditure. Therefore, respectfully following the precedent of the assessee’s own case, which was upheld by the Hon’ble Delhi High Court in assessee’s favour, and also by applying the ratio of judgment of the Hon’ble Delhi High Court in the case of CIT versus EKL Appliances Ltd (supra) we direct the AO/TPO to allow the assessee’s claim for payment of royalty.

7.1.2 We also note that in the revised order passed by the TPO while giving effect to the directions of the Ld. DRP, the TPO made an additional adjustment of Rs. 18,520,144/- on account of arm’s length price of international transaction pertaining to payment of technical guidance fees. We note that no adjustment had been made in this regard by the TPO in the original transfer pricing assessment proceedings. Accordingly, this is an additional adjustment which has been made by the TPO and the same does not emanate either from the original transfer pricing proceedings or from the directions of the Ld. DRP. In such circumstances, this adjustment cannot survive. It has been held by the Hon’ble High Court of Madras in CIT versus Sanmina SCI (I) Pvt. Ltd reported in (2017) 85 taxman.com 29 (Madras) that when an adjustment/addition which was neither proposed in the draft assessment order nor was the same forming part of the directions of the Ld. DRP, the assessing officer/TPO could not make such adjustment while passing the final assessment order. A similar view has been taken by the Pune Bench of the ITAT in the case of Eaton Industries Private Limited versus ACIT in ITA No. 2544/PUN/2012.

Thus, in view of the settled judicial precedent since this additional adjustment was neither proposed by the TPO in the draft assessment order, nor was any such direction given by the Ld. DRP, the adjustment cannot survive. Further, this issue is also covered in favour of the assessee in terms of our observations in the preceding paragraphs pertaining to royalty which is a settled issue in favour of the assessee in assessee’s own case for the different assessment years as above mentioned and also upheld in assessee’s favour by the Hon’ble Delhi High Court. On this ground also, the adjustment does not survive. Accordingly, the TPO/AO is directed to delete this adjustment also.

7.1.3 We also note that the TPO/AO had disallowed the technical know-how fee of Rs. 44,034,540/- which has been capitalised by the assessee as intangibles out of the total technical know-how fees of Rs. 51,050,026/-. We agree with the averments of the Ld. authorised representative that disallowance of an item which has been capitalised by the assessee is wholly erroneous and no addition could have been made with respect to technical know- how which has been capitalised and has not been debited to the profit and loss account. We, accordingly, direct deletion of the same.

7.1.4 Thus, ground nos. 3 (a) to (f) stand allowed.

7.2 Coming to the issue of transfer pricing adjustment of Rs. 55,011,908/- in the manufacturing segment in respect of purchase of raw material from the associated enterprises, it is seen that the assessee has applied TNMM and the Profit Level Iindicator used by the assessee was operating profit/sales by which the Profit Level Indicator had been determined at -5.18% whereas the Profit Level Indicator of the comparables had been determined at -9.06% after carrying out the adjustment on account of capacity utilisation. The TPO was of the view that the assessee had cherry picked 4 out of 17 comparables which were based on qualitative filters. The TPO selected 6 additional comparables from the rejected comparables as contained in the transfer pricing study and determined the profit level indicator of the 10 comparables at 8.86%. The TPO also recomputed the Profit Level Indicator of the assessee at 1% by carrying out certain adjustments in the expenses of the assessee and by estimating an ad hoc 10% increase in some of the expenses as compared to assessment year 2008 – 09 and, thus, worked out the expenses to be considered while working out the Profit Level Indicator of the assessee. The Ld. authorised representative has argued at length against the 6 new comparables introduced by the TPO and the main thrust of the arguments of the Ld. authorised representative is that these comparables pertained to core auto component industries whereas the assessee was manufacturing non-core auto components as it was manufacturing air conditioners for the four wheelers. The Ld. authorised representative has also argued at length that the comparables selected by the TPO had product dissimilarity and, therefore, the same should not be considered as a comparable to the assessee company. The Ld. authorised representative has also very vehemently defended the search process and the selection of comparables by the assessee company and has submitted that the assessee’s comparables were rejected without providing any cogent reasons. The Ld. authorised representative has also placed reliance on the judgment of the Hon’ble Delhi High Court in the case of Rampgreen Solutions Private Limited versus CIT reported in 377 ITR 533 (DEL) for the proposition that in determining appropriate comparables the importance of product and functional dissimilarity has to be properly considered. The Ld. authorised representative has also submitted computations of the average Profit Level Indicators under different scenarios and has argued that under the different scenarios, as reproduced in the earlier part of this order, the assessee will be at arm’s length if the assessee is allowed the benefit of capacity utilisation. The Ld. authorised representative has also made out a strong case for capacity utilization adjustment because there was substantial expansion in the installed capacity of the assessee during the year under consideration. The Ld. authorised representative has also placed extensive reliance on the order of ITAT Delhi Bench in the case of Claas India Pvt. Ltd vs. DCIT (supra) and has submitted that in this case the ITAT has propounded clear principles as to in which cases the adjustment should be made and in what manner the capacity adjustment should be made. The Ld. authorised representative, while referring to this order, has submitted that the ITAT has ruled that capacity adjustment should be made only in the profit margins of the comparables. The Ld. authorised representative has also submitted that should the ITAT decide to retain all the 6 comparables introduced by the TPO, suitable directions may be given to the TPO to work out the capacity adjustment in line with the order of the ITAT in the case of Claas India Pvt. Ltd vs. DCIT (supra). Therefore, without going into the merits of the suitability of each and every comparable which has been selected by the TPO and which has been very vehemently opposed by the Ld. authorised representative, we deem it appropriate to accept the contentions of the Ld. authorised representative wherein he has pleaded that capacity utilisation adjustment may be directed to be given to the assessee in terms of the order of the ITAT Delhi Bench in the case of Claas India Pvt. Ltd vs. DCIT (supra) while retaining all the comparables.

7.2.1 It is seen that the ITAT Delhi Bench, while considering the assessee’s plea for capacity utilisation adjustment in the case of Claas India Pvt Ltd vs. DCIT (supra), had made the following observations –

“ 10.3 Turning to the facts of the instant case, we find that both the TPO as well as the Ld. CIT(A) have proceeded on a wrong premise not only by allowing capacity utilization adjustment in the assessee’s profit, which is contrary to the legal position as discussed above, but also by considering all the comparables as one unit with the average percentage of their respective capacity utilizations. It is further observed that in the calculation of such capacity utilization adjustment, the Ld. CIT (A) has considered four companies as comparable, which view has been modified by us supra inasmuch as we have held that M/s Eicher Motors and M/s. Force Motors are incomparable. Naturally, they would also go out of reckoning in the computation of idle capacity utilization adjustment. In the absence of the availability of financials of all the comparable companies, it is not possible at our end to work out the amount of capacity adjustment in the manner discussed above. Ergo, we set aside the impugned order and direct the TPO/AO to work out the amount of capacity utilization adjustment afresh in terms of our above observations. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings.”

7.2.2 In the present case before us, it is not in dispute that both the TPO as well as the Ld. DRP has agreed in principle that adjustment with respect to capacity utilisation should be given to the assessee and the dispute centres around the quantum of the adjustment to be given. We also are of the considered opinion that it is a settled issue that the adjustment is to be made in the comparables and not the tested party. For this proposition we place reliance on the order of ITAT Delhi Bench in the case of Frigoglass

India Pvt. Ltd. Vs. ACIT reported in TS-500-ITAT-2016(DEL)-TP and the relevant observations of the Bench are as under –

“5. Having heard the rival contentions and having perused the material on record, we are of the considered view that the assessee’s grievance does deserve to be upheld in principle, even though the computations of the assessee, with respect to this adjustment, are incorrect and need to be revisited. ... There is also no dispute that there were serious issues with respect to its products and there was a fall in production by over 64%. In these circumstances, there was clearly a substantial underutilization of capacity. The stand of the TPO that any fall in utilization of capacity should have been subsidized by the AE is devoid of any basis in the present circumstances. The lapses leading to issues with the quality related issues, as set out in TPO order itself at page 9, are purely production and operational reasons and for these reasons the assessee, as a commercial unit, is responsible. Of course, as the DRP rightly observes, the adjustments are to be made in comparables and not the tested party. Learned counsel also does not dispute that. In view of these discussions, in our considered view, the plea of the assessee deserves to be upheld in principle tough the matter is required to be remitted to the file of the AO for fresh quantification of the adjustment figure by making the necessary changes in the figures of comparables rather than the tested party. The matter stands restored to the assessment stage, with the above observations. ”

7.2.3 Therefore, on an overall consideration of the facts of the case, the settled judicial precedents and the plea of the Ld. authorised representative praying for direction to be given to the TPO to allow capacity utilisation adjustment in terms of the order of the ITAT in the case of Claas India Pvt. Ltd vs. DCIT (supra), we deem it appropriate to restore this issue to the file of the TPO with the direction to adjudicate the issue afresh in accordance with the order of the ITAT in the case of Claas India Pvt. Ltd vs. DCIT (supra) after giving proper opportunity to the assessee to present its case.

7.2.4 Thus, ground No. 4 of the assessee’s appeal stands allowed for statistical purposes.

7.3 Ground No. 5 challenges the adjustment of Rs. 31,683,128/- on account of purchase of finished goods in the trading segment. It is seen that the assessee had purchased trading goods from its associated enterprises and had applied TNMM to benchmark this transaction. The assessee had selected 4 comparables whose average net margin was calculated at (-) 10.14% whereas the assessee’s net margin was (-) 5.77%. The TPO, however, disregarded the search process undertaken by the assessee and proceeded to adjust the price of the trading goods imported. He selected 2 new comparables and worked out the arm’s length margin at 12.96% thereby making a transfer pricing adjustment of Rs. 39,544,739/-. The Ld. DRP provided partial relief to the assessee by directing the reduction of margin of one of the comparables namely Staines Motors and by further holding that foreign exchange fluctuation should be treated as non-operating items for the tested party and the comparables for the purpose of comparability. This resulted in decrease of the assessee’s net margin to (-) 4.59% and reduced the transfer pricing adjustment to Rs. 31,683,128/-. We note that the Department is not in appeal against the reduction directed by the Ld. DRP. The Ld. authorised representative has argued at length against the action of the TPO in rejecting all the 4 comparables selected by the assessee in the trading segment on the ground of persistent losses, negative net worth and functional dissimilarity. The Ld. authorised representative has also vehemently argued against the introduction of one fresh comparable namely United Motors. It has been argued that United Motors is a trader of petrol and diesel and has income from retail business arrangement and, therefore, it is not functionally similar to the assessee company. In the rejoinder to the submissions of the Ld. Sr. DR before us, the Ld. authorised representative has also submitted that, although initially, the assessee was challenging the inclusion of Johnson Control India Private Limited as a comparable but the exclusion of this comparable was not being pressed. The Ld. authorised representative has also prayed for inclusion of the comparable Spectra Industries Ltd which had initially been selected by the assessee in the transfer pricing study but was later rejected by the assessee. The assessee, relying on the judgment of the Hon’ble Punjab and Haryana High Court in the case of CIT versus Quark Systems India (Private) Limited reported in 244 CTR 542 (P&H) has submitted that the assessee cannot be prevented from pointing out a mistake in the assessment though such mistake is the result of evidence produced by the assessee itself. The Ld. authorised representative has submitted that since Spectra Industries Ltd is purely engaged in the trading of auto components, the same should be considered as a comparable and be included in the final set of comparables. It has been submitted that if Spectra Industies Ltd. is directed to be included and United Motors is directed to be excluded, no further adjustment will be required in the trading segment. Thus, in the final list of comparables in the trading segment, the assessee is praying for exclusion of United Motors on the ground of product dissimilarity and inclusion of Spectra Industries Ltd due to functional similarity. Further, the assessee is accepting the other comparable selected by the TPO i.e. Staines Motor Parts Ltd and is also accepting the other comparable Johnson Controls India Private Limited. Therefore, on an overall consideration of the facts and the pleadings of the assessee in this regard, we direct the TPO to compute the arm’s length price with respect to the trading segment after excluding United Motors as the same is functionally dissimilar and after including Spectra Industries Ltd on the ground of functional similarity.

7.3.1 Accordingly, ground No. 5 stands allowed.

7.4 Ground No. 6 challenges the action of the TPO/AO in initiating penalty proceedings under section 271AA of the Act in respect of the international transaction in the nature of purchase of parts and components, payment of royalty and purchase of fixed assets. This ground is dismissed as being premature.

7.4.1 Accordingly, ground No. 6 stands dismissed as premature.

7.5 Ground No. 7 challenges the action of the TPO/Ld. DRP in disallowing an amount of Rs. 407,348/- under section 43B in respect of MODVAT credit which had been adjusted against the excise duty payable before the due date of filing of return. It is seen that this issue is covered in favour of the assessee by order of the ITAT Delhi Bench in assessee’s own case for assessment years 2006 – 07 and 2008 – 09 wherein it had been held by the ITAT that amount of excise duty adjusted against the MODVAT available before the due date of filing of income tax return has to be treated as payments made under section 43B and the same is allowable.

We also note that the Ld. DRP had held this issue in favour of the assessee in its directions for assessment year 2007 – 08. Therefore, on identical facts and without there being any change in the surrounding circumstances, respectfully following the order of the ITAT in assessee’s own case, we direct the TPO to allow the impugned amount after duly verifying the claim. Thus, ground stands allowed for statistical purposes.

7.5.1 Accordingly ground No. 7 stands allowed for statistical purposes.

7.6 Ground number 8 is challenging the disallowance of foreign exchange loss claimed on purchase of imported machinery.

There was a foreign exchange loss of Rs. 18,155,000/- which was claimed by the assessee on the value of machinery imported. It has been submitted by the assessee that this machinery was damaged during the process of unloading in Indian port. It has been further submitted that the AO has disallowed an amount of Rs. 5,181,625/- by holding it as a notional loss not allowable under section 43A. It is the assessee’s plea that the provisions of section 43A would not be applicable on the facts of the present case. It has been submitted by the Ld. authorised representative that this machine has not been put into use and, as such, since the assets had been not utilised for the purpose of running the business, the same would not be covered by the mischief of section 43A. It has also been submitted that this loss is not in the nature of capital loss as the machinery was not put into use. Having duly considered the facts, it is our considered opinion that the fact remains that the machinery was imported on capital account and the same would have formed part of fixed assets of the assessee company. The resultant loss on account of damage of machinery is also, accordingly, on capital account and by no stretch of omagination can it be considered as a business loss. The Ld. AR has placed reliance on the judgment of the Hon’ble Delhi High Court in the case of Indo Rama Synthetics (I) Ltd. vs. CIT reported in 333 ITR 18 (Del) and has submitted that when a project is abandoned and no new asset has come into existence, the expenditure incurred earlier on capital account was allowable as a revenue expenditure. We are afraid that this judgment of the Hon’ble Delhi High Court does not help the case of the assessee as in the present case there has been no abandonment of the project and the business of the assessee company has continued irrespective of the damage to the machinery. On similar reasoning, the judgment of the Hon’ble Delhi High Court in the case of CIT vs. Priya Roadshows Ltd. reported in 332 ITR 594 (Del) does not help the cause of the assessee. It is our considered opinion that the nature of loss remains a short term capital loss which is either to be adjusted against the existing block of assets or is to be claimed separately as a short term capital loss but cannot be treated as a business loss or expenditure so as to be allowable u/s 28 or u/s 37 of the Act. Accordingly, we are unable to differ from the directions of the Ld. DRP on the issue and we dismiss the ground raised by the assessee.

7.6.1 Accordingly, ground no. 8 stands dismissed.

7.7 Ground No. 9 is again a general ground and the same is not being adjudicated upon.

7.8 Ground No. 10 challenges the initiation of penalty proceedings under section 271 (1) (c) of the Income Tax Act, 1961.

This ground is also dismissed as being premature.

7.9 Ground No. 11 challenges the levy of interest under sections 234A, 234B and 234C. The levy of interest is consequential and will have to be levied as per the provisions of law.

7.10 In the result, the assessee’s appeal stands partly allowed.

However, the jurisdictional High Court in Pr. CIT Vs. Ameriprise India Pvt. Ltd. in ITA 206/2016 has held that foreign exchange loss was to be considered as part of operating cost. It follows that in case the assessee is treating the fluctuation loss as non-operating, then the adjustment is to be allowed in the hands of comparables also. While applying the transfer pricing provisions, the TPO has to make sure that like is compared to like. So, in case income or cost is recognized in a particular manner by the assessee and the margins are computed there under by the assessee, then similar recognition of income/cost is to be given in the hands of comparables. Since, the directions of the Ld. DRP do not spell out the reasons behind treating the foreign exchange loss as non- operating, we remit this issue back to the file of TPO to verify the claim of assessee in this regard and if the assessee has given similar recognition to the foreign exchange income/loss by treating it as non-operating income/cost respectively, then the margins of comparable be similarly worked out. Needless to say, the assessee is to be provided with a proper opportunity by the TPO in this regard.

8.0.1 Accordingly, the additional ground of the department stands allowed for statistical purposes.

8.1 Ground No. 1 challenges the addition of Rs. 17,57,677/- deleted by the Ld. DRP. During the year, the assessee had incurred an expenditure of Rs. 5,638,160/- towards utilising a business centre owned by M/s Panalfa Automotive Pvt. Ltd as against Rs. 5,424,000 paid in the assessment year 2008 – 09. The AO proceeded to make a disallowance under section 40A(2)(b) of the Act. The AO estimated an increase of 10% while allowing the business centre charges over the immediately preceding year. The Ld. DRP decided the issue in assessee’s favour by following the order of the ITAT in assessee’s own case in assessment year 2003 –

4. The Ld. DRP while directing the deletion of the impugned amount has noted that since the Department had not preferred an appeal before the Hon’ble High Court against the order of the ITAT on this issue, the proposed disallowance cannot be sustained. We also note that again in assessment years 2004 – 05 and 2005 – 06 the Department did not file an appeal before the Hon’ble High Court on this issue although other issues were litigated before the Hon’ble High Court. Thus, in view of the facts being identical, we find no reason to interfere with the directions of the Ld. DRP on this issue and we dismiss ground No. 1 raised by the Department.

8.1.1 Accordingly, ground No. 1 of the Department’s appeal stands dismissed.

8.2 Coming to ground No. 2 of the Department’s appeal which challenges the deletion of addition of Rs. 3,023,000/- on account of provision for warranty expenses we find that the Ld. DRP, while deleting the addition, has categorically observed that the assessee has been regularly making similar provisions on a scientific and reasonable basis in earlier assessment years and which have been allowed year after year from assessment year 2006 – 07 to assessment year 2008 – 09. The Ld. DRP has also followed the judgment of the Hon’ble Apex Court in the case of Rotork Controls India Private Limited versus CIT reported in 314 ITR 62 (SC) while giving relief to the assessee in this regard. It is not in dispute that the provision for warranty is being made year after year and the Ld. DRP has duly noted in its directions that regular system of accounting is being followed by the assessee year after year for making provision on a scientific basis. During the course of proceedings before us the Department could not point out any factual inaccuracy in the directions of the Ld. DRP. In such a situation, we are unable to interfere with the directions of the Ld. DRP in this regard and we dismiss ground No. 2 raised by the Department.

8.2.1 Accordingly, ground No. 2 of the Department’s appeal also stands dismissed 8.3 Ground numbers 3 and 4 of the Department’s appeal are general and are not being adjudicated upon.

8.4 In the result the appeal of the Department stands partly allowed.

Order is pronounced in the open court on 19th June, 2018.