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Income Tax Appellate Tribunal, ‘D’ BENCH, CHENNAI
Before: SHRI A.MOHAN ALANKAMONY & SHRI DUVVURU RL REDDY
आदेश / O R D E R
PER A. MOHAN ALANKAMONY, ACCOUNTANT MEMBER:
This appeal by the assessee is directed against the order passed in pursuance of the directions of the Ld. Members of the Dispute Resolution Panel U/s.143(3) r.w.s 144C(5) of the Act dated 30.12.2015 for the assessment year 2011-12.
2. The assessee has raised 19 grounds running to 4 pages however the Ld.AR on the directions of the Bench submitted the concise grounds which are summarized as follows: (i) The Ld.AO, TPO, DRP have erred in making adjustment
with respect to employee cost and depreciation of the comparable companies. (ii) Despite the directions of the Members of the DRP the Ld.DCIT in his order giving effect has erred in treating foreign exchange fluctuations as non-operating item for computing the net margin.
(iii) The Ld.TPO as well as the Ld.DCIT in his order giving effect to the directions of the Members of the DRP has erred in excluding, miscellaneous income and revenue generated from sale of scrap, while computing the PLI of the assessee.
The brief facts of the case are that the parent company of the assessee is Singapore based Flextronics Group of Companies. The assessee company is engaged in the business of electronic manufacturing service provider and also engaged in assembling electronics components in the printed circuit board for mobile chargers. In the TP documentation the assessee company had adopted TNMM as most appropriate method and computed its PLI by dividing operating profit viz., cash profit by operating income multiplied by 100 (OP/OI * 100). The assessee company had identified seven companies as comparable companies by adopting certain search criteria with respect to its AE transaction.
The filters adopted by the assessee company were as follows: i. Electronic equipment/semiconductor equipments/PCB’s. ii. Companies for which sufficient financial information was not available for the F.Y. 2008-09, F.Y. 2009-10 and F.Y. 2010-11. iii. Sales not greater than zero. iv. The ratio of manufacturing income/total income less than 10%. v. Companies undergoing business restructuring. vi. Companies whose segmental information is not available. vii. Companies with different scale of operations. viii. Companies reporting persistent operating losses and ix. Companies engaged in significant related party transactions.
The Ld.TPO on examining the search criteria adopted by the assessee company opined that certain filters are not relevant because of the following reasons:-
Sl.No. Search Criteria Remarks of the TPO 1. Companies for which To compute the ALP the data sufficient financial relevant for respective financial year information was not has to be used. Moreover under available for the F.Y. section 92CA(3) the TPO is entitled 2008-09, F.Y. 2009-10 to consider material available in and F.Y. 2010-11. public domain relevant for the FY during TP assessment, though not available to the assessee at the time of TP study. Hence, this filter is not an appropriate filter.
Sales not greater than The companies having turn over less zero than 1 crore has to be rejected as the operations of these companies is highly influenced by shareholders and Directors.
3. Companies with different As per various Judicial scale of operations. Pronouncements the companies having turnover 5 to 10 times can be considered as comparable. 4. Companies engaged in The assessee has not applied the significant related party quantum of RPT. The companies transactions. having RPT more than 25% has to be rejected.
The Ld.TPO also opined that gain or loss arising out of foreign exchange fluctuations has to be excluded while computing the PLI. Thereafter the Ld.TPO based on his independent search selected 10 companies as the comparable companies which included seven companies selected by the assessee. Further the Ld.TPO arrived at the conclusion that the comparable companies have underutilized capacity in terms of employee cost and also excess depreciation which reduce the profit of the comparable companies. Thereafter the Ld.TPO worked out the average employee cost to operating income of comparable companies at 11.45% as against assessee’s ratio of 7.22%. Further the ratio of depreciation to operating income of comparable companies was worked out at Rs.4.79% as against the assessee’s ratio of 1.79%.
Since there was a wide disparity the Ld.TPO made the relevant adjustments while computing the PLI of the comparable companies.
On appeal, the Ld.Members of the DRP gave directions to treat the gain/loss arising out of the foreign exchange fluctuation as the operating income/loss in respect of the assessee company as well as the comparable companies while determining the ALP provided there is no element of forward contract.
Further the Ld.Members of the DRP observed in their order that there are certain filters which the assessee company had not applied and therefore it was incumbent to cure the same while computing the ALP. The Ld.Members of the DRP further observed that the computation of ALP by the Ld.TPO is appropriate because the adjustments were made with proper valid reasoning and explanations.
At the outset the Ld.AR submitted before us that the capacity utilization in the case of the assessee company is less than the other comparable companies. To drive his point he referred to page No.155 of the Paper Book, wherein the average capacity utilization of the comparable companies was worked out at 84.03%. It was further submitted that the capacity utilization of the assessee company is 79.18%. It was therefore argued that the adjustment has to be made only by increasing the profit margin of the assessee company and not by increasing the profit margin of the comparable companies. When these arguments were put before the Ld.DR he could not controvert to the submission made by the Ld.AR because the capacity utilization worked out by the assessee company could not be disputed. The capacity utilization worked out by the assessee company is reproduced herein below for reference:-
Installed Capacity Sl.No. Name of the company Production capacity utilization (%) 1 Akasaka Electronics Limited 7,20,000 4,82,024 66.95 2 BBC Fuba India Limited 23,400 19,818 84.69 Circuit Systems (India) Flexible 3 56,249 100 Limited capacity 4 Fine Line Circuits Limited 31,000 22,520 72.65 Centum Electronics 5 - - 100 Limited* Precision Electronics 6 20,500 15,921 77.66 Limited Aishwarya Technologies and 7 - - 100 Telecom Limited* 8 BLG Electronics Limited 40,000 31,350 78.38 Epitome Components 9 - - 100 Limited* 10 Sulakshana Circuits Limited 43,200 25,897 59.95 84.03 Average * It is pertinent to note that as these companies have not reported in the annual report, any under-utilisation of capacity. Hence, these companies are considered to be operating at normal capacity levels.”
After hearing both sides, we find merit in the submission of the Ld.AR. From the above mentioned facts it is obvious that the cause of higher employment cost of the comparable companies compared with the assessee company cannot be attributable to their level of capacity utilization. However nothing further is brought before us by both the parties to explain the reasons for the higher employee cost incurred by the comparable companies though it is accepted by both the parties that those companies are comparable companies. In these circumstance the very fact that the employee cost incurred by the comparable companies being higher than the assessee company’s employee cost, brings doubt into our minds, as to whether actually the comparable companies accepted by the assessee company and the Revenue are appropriate for computing the ALP. It is an acceptable proposition that normally employee cost will be higher when skilled labour is deployed in the functioning of the entities. In normal circumstances and business conditions there cannot be any other reason to hold otherwise. In such situation it can be safely presumed that the nature of work carried out by the assessee company might not require much skill than the work carried out by the comparable companies. If that being so the comparable companies adopted by the assessee company and the Revenue cannot be strictly viewed as comparable companies.
Further from the materials produced before us we do not find any functional analysis carried out with respect to the employee cost while examining the intricacies of the assessee company and the comparable companies while arriving at the ALP. The issue with respect to adjustment towards depreciation also stands on the same footing. Therefore we are of the view that the entire matter with respect to the comparable companies is required to be examined afresh by the assessee as well as the Ld.Revenue Authorities. Hence, we hereby remit the matter back to the file of Ld.TPO for de-nova consideration. Accordingly Ground No. 2(i) is disposed off.
With respect to the issue of adjustment towards foreign exchange fluctuations, the Ld.Members of the DRP relying on the decision of the Tribunal in the case SAPLab India Pvt. Ltd. (2010- TII-44-ITAT-Bang-TP) directed the Ld.TPO to treat the gains/loss arising out of the foreign exchange fluctuations in respect of the assessee company as well as the comparable companies as operating income/loss while determining the ALP, provided the assessee companies as well as the comparable companies has not indulged in forward contracts. However on perusing the order giving effect to the directions of the Ld.DRP as pointed out by the Ld.AR we find that the Ld.DCIT has omitted to consider the same while computing the ALP. Since the Ld.Member’s of the DRP had only followed the decision of the Tribunal we hereby direct the Ld.TPO to comply with the above mentioned direction of the Ld.Members of the DRP while computing the ALP in the case of the assessee company. Accordingly Ground No.2(ii) is disposed off.
The Ld.AR further alleged before us that the Ld.TPO as well as the Ld.DCIT in their order giving effect to the directions of the Members of the DRP has excluded the miscellaneous income and revenue generated from the sale of scrap while computing the PLI of the assessee. He argued stating that both the miscellaneous income and the sale of scrap are directly attributable to the operating income of the assessee and hence they should be taken into account for the purpose of computing the PLI of the assessee. We find merit in the submission of the Ld.AR. However it is pertinent to mention that the nature of miscellaneous income and the revenue generated from sale of scrap has to be verified whether it is actually the constituent of the operating profit because if the scrap sold is not the residue attributable with respect to the manufacturing operations then the same cannot be taken as a constituent of the operating income. So is the case with respect to miscellaneous income. For example, sale of scrap resulting from any fixed asset of the assessee company cannot be taken as a constituent of operating income. Similarly miscellaneous income not connected with the business activities of the assessee company cannot be taken as a constituent of the operating income. Since the real nature of miscellaneous income and revenue arising out of the sale of scrap is not before us, we are of the considered view that this issue is also to be looked into afresh. Therefore we hereby remit these issues also back to the file of Ld.TPO in order to pass appropriate order based on our observations made herein above. Accordingly Ground No.3 is disposed off.
In the result, the appeal of the assessee is allowed for statistical purposes as indicated herein above.
Order pronounced on 04th December, 2017 at Chennai.