FRIGOGLASS INDIA PVT. LTD.,GURGAON vs. ACIT, NEW DELHI

By way of this appeal, the assessee appellant has challenged correctness of the order dated 30th January 2016 passed by the Assistant Commissioner of Income Tax Circle 9(2) New Delhi, under section 143(3) r.w.s 144C of the Income Tax Act, 1961, for the assessment year 2011-12/

Grievances raised by the appellant, so far as transfer pricing issues are concerned, are as follows:

As the hearing progressed and as we narrowed down to the precise issues requiring our adjudication, learned representatives fairly agreed that the short issues that we are required to decide, however, is (a) whether or not the Assessing Officer was justified in declining capacity utilization adjustment, in respect of computation of arm’s length price on sale of finished goods, components and spares; and (b) whether or not the Assessing Officer was justified in making an arm’s length price adjustment of Rs 8,77,31,148 by rejecting the assessee’s determination of ALP of these services under the TNMM, and by adopting the arm’s length price of the same services, under CUP method, at NIL value.

As far as the first issue is concerned, the relevant material facts are like this. The assessee before us is a subsidiary of Norcoolding ASA, Norway. The assessee is engaged in the business of glass door merchandising. It has a manufacturing plant which caters to the domestic market as also to exports to neighbouring Asian countries. During the course of proceedings before the Transfer Pricing Officer, one of the issues which came up for scrutiny was capacity underutilization adjustment. The TPO noted that the assessee was informed by his key customer, i.e. Coca Cola, of likely performance failure in some of the visicoolers sold and installed by it. Subsequently, because of the fault of the products already sold, the assessee’s sale dwindled. As against a production of 1,11,000 visicoolers in the immediately preceding year, the assessee could produce only 39,500 visicoolers in the current year. As evident from a reading of the TPO’s order, the assessee explained the detailed reasons of technical failures, on the part of the assessee, leading to this Assessment year: 2011-12 Page 4 of 7 underutilization of capacity. The TPO, however, did not accept this adjustment. His primary reliance was on the decision of a coordinate bench of this Tribunal, in the case of DCIT Vs EDAG Engineers & Designs India Pvt Ltd [(2014) 67 SOT 81 (Del)] and referred to its observations to the effect that “…. the very concept of capacity underutilization may not really make any sense unless the assessee has not been able to offer, for reasons beyond its control, the underutilized capacity to its AE. There is no finding on this aspect of the matter. As the assessee does not have the liberty to work for any other customer, and is wholly dependent on its AE for productive use of its capacity to work, the AE should normally make good any losses to the captive unit caused by its not being able to make use of the available capacity”. The TPO was of the view that “the reason that the assessee has put forward in its explanation does not seem to be such that are beyond his control”. It was noted that the assessee does not carry out any R&D activities or product design of its own, and, therefore, the underutilization of capacity is due to mistakes of the AEs. The TPO stated that “revenue (authorities) should not be expected to subsidize determination of ALP”. The TPO the observed that in any case what could be relevant in making capacity underutilization adjustment is when ALP is being determined for the raw material rather than sales. It is only when purchases are being made from the AEs and the revenues are being generated from the unrelated parties that such an adjustment, even theoretically, can come into play. In view of these discussions, and noting that “AE should have provided some price support to the assessee”, the TPO rejected the capacity underutilization adjustment. The assessee did raise an objection before DRP but without any success. The DRP noted that “the TPO has given valid reasons for not accepting the assessee’s claim” and that “the assessee has failed to controvert the reasons given by the TPO for rejecting the assessee’s claim for capacity adjustment”. In any event, as the DRP noted, the adjustment is required to be made in the comparables rather than the tested party. The ALP adjustments, accordingly, were made in respect of sale of finished goods for Rs 1,51,68,845 and in respect of sale of components and spares for Rs 87,90,105 Aggrieved by the stand so taken by the DRP, the assessee is in appeal before us. Assessment year: 2011-12 Page 5 of 7 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. We have noted that the fundamental reason for the impugned rejection by the TPO is his reliance on EDAG decision (supra) by the coordinate bench and he has extensively quoted from this decision. However, what has been missed out is that EDAG was a one hundred percent captive unit and the Tribunal had specifically given its decision in this context. When AO quotes the words “…. the very concept of capacity underutilization may not really make any sense unless the assessee has not been able to offer, for reasons beyond its control, the underutilized capacity to its AE”, he misses out the opening words of this sentence to the effect “That apart, in the case of a one hundred percent captive service unit, as is the assessee before us”. The correct and complete sentence was “That apart, in the case of a one hundred percent captive service unit, as is the assessee before us, the very concept of capacity underutilization may not really make any sense unless the assessee has not been able to offer, for reasons beyond its control, the underutilized capacity to its AE”. It is thus clear that the observations of the coordinate bench, which one of us (i.e. the Accountant Member) had the occasion to articulate, was specifically in the context of one hundred percent captive units. That is not the case here. 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 Assessment year: 2011-12 Page 6 of 7 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.

As for the second issue, that was a matter taken up at the DRP only inasmuch as an enhancement was made by the DRP in this regard. During the course of the proceedings before DRP, it was noticed that in the immediately preceding assessment year, i.e. 2010-11, the TPO had made an ALP adjustment of Rs 29,65,700 in respect of management fees and of Rs 8,47,65,448 in respect of royalty and licence fees, and these ALPs were confirmed by the DRP. The DRP required the assessee to show cause as to why similar ALP adjustment not be made for this assessment year as well, as the relevant facts and circumstances are similar. It was in this backdrop, and after rejecting the submissions against the enhancement, that the DRP directed the Assessing Officer to make “similar (arm’s length price) adjustment towards royalty and management fees as has been upheld by the DRP in 2010-11”. When the matter thus travelled back to the Assessing Officer, he made an ALP adjustment of Rs 5,41,00,671 as against ALP adjustment of Rs 2,39,58,750 as originally proposed by the TPO. The assessee is aggrieved and is in appeal before us.

Having heard the rival submissions and having perused the material on record, we find that the issue is covered, in favour of the assessee,the order dated 8th April 2016 passed by a coordinate bench, in assessee’s own case for the assessment year 2010-11. There is no occasion to take a different view of the matter for this year. In any event, one can discard the TNMM and proceed to adopt CUP only when a comparable product or service is available. When no such comparable is available, as in this case, there cannot be any occasion to resort to CUP, and, as such, in such a situation, CUP cannot be accepted as MAM over the TNMM. The very approach underlying these ALP adjustments is not fallacious and legally unsustainable. We, therefore, direct the Assessing Officer to delete ALP in respect of royalty and management fees.

The only other grievances, which pertain to non TP matters and which require our adjudication, are in respect of disallowance of 5% of miscellaneous expenses Assessment year: 2011-12 Page 7 of 7 amounting to INR 315,246 on ad-hoc and arbitrary basis by stating that the expenditure incurred by the Appellant is not totally vouched and in respect disallowance of Rs.45,314 on account of non reconciliation of the information filed in annual income and income as per profit and loss account.

We have noted that as far as the adhoc disallowance of 5% is concerned, the DRP has already referred the matter to the AO, with a direction that in case assessee can produce the related bills and vouchers, the same shall be deleted. As for the second issue of disallowance of Rs 45,314 in the absence of reconciliation statement, that issue has not even been taken up before the DRP. No arguments were advanced on these issues either.

No interference is thus called for on the non transfer pricing issues. These grievances are rejected.

In the result, the appeal is partly allowed in the terms indicated above. Pronounced in the open court today on 25th day of July, 2016.