ESSILOR MANUFACTURING INDIA PRIVATE LIMITED,BANGALORE vs. DCIT, BANGALORE

Per Shri Vijay Pal Rao, J.M. : These are cross appeals for the Assessment Year 2008-09 and appeal by the

assessee for the Assessment Year 2009-10 against composite order

dt.29.05.2014 of the Commissioner of Income Tax (Appeals)-IV, Bangalore.

2 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 2. For the Assessment Year 2008-09, the assessee has raised the following

grounds :-

1 Assessment and reference to Transfer Pricing Officer are bad in law. a) The order issued by the Deputy Commissioner of Income-tax - Circle 11(3) [‘AO’] under section 143(3) of the Income-tax Act, 1961 [‘the Act’], and the order passed by the Commissioner of Income-tax (Appeals)-IV, Bangalore [‘the CIT(A)’] under section 250 of the Act are bad in law and on facts. Without prejudice to the to the generality of the above, the order issued by the AO is bad in law insofar as the fact that the AO did not issue to Essilor Manufacturing India Private Limited (‘the Appellant or ‘the Company’), a show cause notice as per proviso to section 92C(3) of the Income-tax Act, 1961 [‘the Act’]. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The AO erred in law in making a reference to the Assistant Commissioner of Income-tax (Transfer Pricing) - VI [‘TPO’], inter alia, since he has not recorded an opinion that any of the conditions in section 92C(3) of the Act, were satisfied in the instant case. The AO also erred in not following the provision contained in section 92CA(1) of the Act. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. c) On the facts and in the circumstances of the case and in law, the Ld. TPO erred in not demonstrating that the motive of the Appellant was to shift profits outside India by manipulating the prices charged in the international transaction, which is a pre-requisite condition to make any adjustment under the provision of Chapter X of the Act. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. d) The order issued by the AO, is bad on facts and in law and is in violation of the principles of natural justice. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. e) The order passed by the AO is without jurisdiction, inter alia, insofar as it purports to give effect to an invalid order of the TPO. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. 2 Comparability analysis adopted by the AO/TPO for determination of the arm’s length price is bad in law a) On the facts and in the circumstances of the case and in law, the Ld.AO/ TPO erred in disregarding the benchmarking analysis and comparable companies selected by the Appellant in the transfer pricing study report maintained as per section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 [‘the Rules’] without considering the functional and risk profile of the Company. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The AO/ TPO erred on facts and in law in rejecting one method [‘Cost Plus Method’] and selecting another method [‘Transactional Net Margin Method’] as the most appropriate

3 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 method without providing cogent reasons to the Appellant for rejecting the method adopted by the Appellant. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. c) The AO/TPO erred on facts and in law in conducting a fresh benchmarking analysis using non contemporaneous data and substituting the Appellant’s analysis with fresh benchmarking analysis on his own conjectures and surmises and introducing new comparable companies, without providing an opportunity to the Appellant. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. d) The AO/ TPO erred in rejecting the segment-wise profit and loss for FY 2007-08. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. 3 Erroneous data used by the AO/TPO a) The AO/TPO erred in law and the Ld. CIT(A) further erred in confirming use of data, which was not contemporaneous and which was not available in the public domain at the time of conducting the transfer pricing study by the Appellant. b) The AO/TPO erred in law and the Ld. CIT(A) further erred in confirming non-application of multiple-year data while computing the margin of alleged comparable companies. 4 Non-allowance of appropriate adjustments to the comparable companies, by the AO/TPO a) The AO/TPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (a) accounting practices, (b) depreciation adjustments, (c) research and development expenditure adjustment and (d) capacity under-utilisation adjustment between the Appellant and the comparable companies. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The Ld. CIT(A) erred in rejecting capacity adjustment citing reasons that the working capital adjustment has been allowed to the Company. Further, the Ld. CIT(A) erred in incorrectly observing that the Appellant had not provided workings for capacity under- utilisation adjustment in relation to comparable companies identified by the TPO in his order. 5 Variation of 5% from the arithmetic mean The AO/TPO erred in law in not granting the variation as per the proviso to Section 92C(2) of the Act. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. 6 Disallowance of prior period expenses a) The AO erred in disallowing a sum of Rs.11,03,000 incurred by the Appellant towards Overtime labour charges debited under the head ‘Prior Period Expenses’. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The AO failed to mention the fact that the expenses though relate to prior period, has come up only due to settlement made with the employees during the relevant AY in consideration. The Ld. CIT(A) erred in not adjudicating the above ground.

4 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 7 Initiation of penalty proceedings The Appellant submits that based on the facts and circumstances of the case, there was no basis for the AO to propose to initiate proceedings under section 271(1)(c) of the Act. 8 Relief a) The Appellant prays that directions be given to grant all such relief arising from the above grounds and also all relief consequential thereto. b) The Appellant craves leave to add to or alter, by deletion, substitution, modification or otherwise, the above grounds of appeal, either before or during the hearing of the appeal. c) Further, the Appellant prays that the adjustment in relation to transfer pricing matters made by the AO / TPO and upheld by the Ld. CIT(A) is bad in law and liable to be deleted.”

the learned counsel for the assessee. Accordingly, no specific adjudication is

required in respect of Ground No.1.

4.1 Ground No.2 is regarding rejection of the Transfer Pricing analysis as well

as Cost Plus Method (in short ‘CPM’) and adopting another method being

TNMM as Most Appropriate Method (in short ‘MAM’) by the Transfer Pricing

Officer (TPO). The assessee, Essilor Manufacturing India Pvt. Ltd. (EMIL) is

engaged in the business of manufacture of plastic-opthalmic lenses. The

assessee is a wholly owned subsidiary of Essilor International S.A., France. The

assessee is manufacturing lenses and selling the same to its foreign group

companies as well as marketing and distribution to the group companies in

India. The raw material for manufacturing of ophthalmic lenses is imported by

5 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 the assessee from its overseas group companies. Thus the assessee is

purchasing the raw material from its Associated Enterprises (AEs) and also

selling the plastic ophthalmic lenses to its AEs as well as in India group

companies. The assessee reported the international transactions carried out

during the year under consideration as under :-

Nature of Services Receipts (Rs.) Payment (Rs.) Purchase of raw material, spares, 4,17,15,955 --- consumables. Sale of finished goods. --- 14,84,15,357 Purchase of plant & machinery 16,98,775 Recovery of expenses. 37,46,231

To Benchmark its international transactions, the assessee adopted CPM as

MAM and compared the average gross margins of the comparables at 34.83%

with that of the assessee at 45.42%. Thus the assessee claimed that its

international transactions are at Arms’ Length. The assessee has also used the

TNMM as supplementary method. The assessee selected 5 comparables to

benchmark the transaction under TNMM with Mean Profit Level Indicator (PLI)

of 7.93% as against the PLI of the assessee at – 7.12%. The assessee also

adjusted for the unutilized capacity of the plant and arrived at 15.71%

operating profit on sale and claimed that the operating profit on sale of the

6 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 assessee is more than the operating profit margins of its comparables and

therefore the transaction with AEs are claimed to be at arms length. The TPO

observed that certain portions of the expenses have been retained as

unapportionable and these expenses pertains to the business of the assessee

and needs to be apportioned according to the AE and non-AE sales. Thus the

TPO has reworked out the operating margin of the assessee at 4.38% in respect

of the international transactions. The TPO rejected the TP analysis of the

assessee as well as the CPM as Most Appropriate Method and adopted the

TNMM as MAM for determination of the Arms Length Price (ALP). The list of

comparables selected by the assessee as under :-

Sl.No. Company GPM 2005- GMP 2006- GPM 2007- Weighted 06 (%) 07 (%) 08 (%) Average 1. GKB Opthmalmics 45.01 34.86 39.26 39.40 Ltd. 2. Jai Mata Glass Co. 9.79 15.88 21.72 17.50 Ltd. 3. La Opala R G Ltd. 44.16 43.24 41.35 42.84 4. Techtran 52.54 55.34 54.62 54.17 Polylenses Ltd. 5. Triveni Glass Ltd. 22.22 16.09 NA 20.23 Arithmetic Mean 34.83

7 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 The TPO found that only two of them namely GKB Opthalmics Ltd. and

Techtran Polylenses Ltd. are functionally similar as they are in the business of

manufacturing of lenses and 3 others are in the business of manufacturing of

glass for commercial purpose. Accordingly the TPO rejected the three of the

comparables selected by the assessee as under : 1. Jai Mata Glass Co. Ltd.

The TPO thereafter carried out a fresh search and selected two more

comparables apart from two selected by the assessee. The TPO has arrived at

Arithmetic Mean (AM) by considering the four comparables as under :

Sl.No. Comparable Company Sales Op. Profit/ OP. Profit/ Cost (%) Sales (%) 1. GKB Ophthalmics Ltd. 18.77 9.89 9.00 2. GKB VisionLtd. 29.46 22.75 18.53 3. Techtran Polylenses Ltd. 24.49 16.45 14.13 4. General Optics (Asia) Ltd. 9.28 42.99 30.06 Arithmetic Mean Margin 23.02 17.92

Accordingly, the TPO proposed an adjustment of Rs.3.30 Crores on account of

ALP of international transactions. The assessee challenged the action of the

8 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 TPO/A.O. before the CIT (Appeals) but could not succeed qua the issue of the

rejection of the CPM by the TPO and adopting TNMM as MAM.

4.2 Before us, the learned Authorised Representative of the assessee has

submitted that the assessee is not in full fledged manufacturing activity but

more into process activity which involves the process of casting and coating of

plastic ophthalmic lenses. The learned Authorised Representative has further

submitted that since raw material is imported from the group companies and

the entire sale is made to the AEs as well as domestic group companies,

therefore, the assessee is more doing a job work than manufacturing and

selling. He has further submitted that a different raw material used by the

various comparable companies making them uncomparables under TNMM. In

support of his contention he has relied upon the decision of the co-ordinate

benches of this Tribunal in the case of GE Medical Systems India Pvt. Ltd. Vs.

DCIT 61 Taxmann.com 109 and submitted that the Tribunal while dealing with

an identical issue has made a reference to the UN Practical Transfer Pricing

Manual and Guidelines for use of CPM. Thus the CPM is typically applied in

costs involving the inter-company sale of tangible property where the Related

Party manufacturer perform limited manufacture functions or in the case of

9 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 intra group provisions of services. The method usually assume the incurrence

of low risk of cost will then be better reflected the value being added and hence

the market price. The CPM is also generally used in transactions involving by

contract manufacturer, toll manufacturer or a low risk assembler which does

not own product intangible as incurred little risk. Thus the learned Authorised

Representative has submitted that in view of the decision of the co-ordinate

bench in the case of GE Medical Systems Pvt. Ltd. (supra), the orders of the

authorities below in rejecting the CPM as MAM be set aside and allow the CPM

as MAM for determination of ALP in view of the international transactions.

4.3 On the other hand, the learned Departmental Representative has relied

upon the orders of authorities below and submitted that the TPO has

specifically pointed out that the assessee has categorized certain portions of

the expenses as unapportionable whereas these expenses pertains to the

assessee and were required to be apportioned between AE and non-AE sales.

Further, the assessee is not a contract manufacturer but the assessee is

purchasing the raw material and therefore owns the raw material used for

manufacturing of the ophthalmic plastic lenses which are sold to the AEs as well

as domestic group companies. Further, in order to adopt the CPM as MAM the

10 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 value added by the assessee under the contract manufacturing or job work is

the basic criteria of determining the ALP whereas in the case of the assessee,

the assessee is purchasing raw material which is a separate transaction and

thereafter doing the manufacturing work and then selling the product to its AEs

and other group companies. Even otherwise when the business activities of the

assessee as well as the comparables are not having the identical component of

cost then the CPM cannot be applied for the purpose of determining the ALP.

Thus the learned Departmental Representative has supported the orders of

authorities below.

4.4 We have heard the rival submissions as well as considered the relevant

material on record. The main thrust of the argument of the assessee is finding

of the Tribunal in the case of GE Medical Systems India Pvt. Ltd. (supra) as well

as the guidelines enumerated in UN Practical Transfer Pricing Manual for the

purpose of use of Cost Plus Method. The Tribunal after considering the

peculiar facts of the said case as well as the guidelines under the UN Practical

Transfer Pricing Manual has held in paras 49 & 50 are as under :

“ 49. Having said so, one should embark upon the stand taken by the Assessee as to why TNMM is the most appropriate method to be adopted for determining ALP in the case of the Assessee. The arguments advanced on behalf of the Assessee have already been set out in the earlier part of this order and are not being repeated. The arguments proceed on purely theoretical basis without citing

11 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 as to how the required data of direct and indirect costs of production of the property in the case of the comparable companies chosen by the TPO are not available. No specific instance as to how in the case of comparable companies chosen by the TPO, indirect costs of production has been taken at the net profit level. The other argument was that the Assessee is a contract manufacturer and the comparable companies selected should also perform a function performed by a contract manufacturer. If comparable companies perform functions beyond that of a contract manufacturer then they are not comparable. This argument is again general in nature without any particulars on the three comparable companies chosen by the TPO.

It is clear from the finding of the Tribunal that in the case of GE Medical

Systems India Pvt. Ltd. (supra), the assessee was a contract manufacturer and

therefore the Tribunal was of the view that for the purpose of TNMM the

comparable companies selected should also perform a function performed by

the contract manufacturer. Thus the basic reason for not accepting the TNMM

as MAM by the Tribunal was that the assessee was a contract manufacturer

12 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 and comparables selected by the TPO were not functionally similar to the

assessee and were also in manufacturing the medical consumables. In the case

on hand undisputedly the assessee has not undertaken the job work or a

contract manufacture for its AEs but the assessee is carrying out its

independent activity of manufacturing the ophthalmic plastic lenses by using

the raw material purchased from the AEs as well as from other parties. There is

no contract between the assessee and its AEs regarding the remuneration and

mark up in respect of the value added by the assessee in the manufacturing

process and further when the assessee is using the raw material of its own and

not supplied by the AE for job work or contract manufacturing. Further, we

find that there are variations of cost components in respect of the

manufacturing activity of the assessee as well as the other comparables

selected either by the assessee or by the TPO. The assessee is also seeking

adjustment on account of variation of depreciation method applied by the

assessee in comparison to the comparables which itself shows that the cost

components of the assessee are in variations with that of the comparables and

therefore in our considered opinion CPM cannot be regarded as MAM in the

case of the assessee. Accordingly, we uphold the orders of the authorities

13 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 below on this issue in rejecting the CPM as MAM and adopting the TNMM as

MAM for determination of ALP. This ground is decided against the assessee.

5.1 Ground No.3 is regarding rejection of the Multi Year Data adopted by the

assessee while computing the margins of the comparables and considering the

current year data by the TPO for the purpose of determining the ALP.

5.2 At the time of hearing, the learned Authorised Representative of the

assessee has not advanced any argument on this ground. However, it is settled

proposition of law as well as the mandate of the provisions of transfer pricing

that so far as it is possible the current year data of the comparables are to be

used for the purpose of determination of ALP. It is provided under Rule 10B(4)

of the I.T. Rules that the data to be used in analyzing the comparability of the

uncontrolled transaction shall be the data relating to the financial year in which

the international transaction has been entered into. Only as an exception the

data relating to not more than two years prior to the such financial year may be

considered, if such data reveals fact, which could have an influence on

determination of transfer pricing in relation to the transactions being

compared.

14 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 5.3 Rule 10D(4) further states that the information and documents specified

under sub-rules (1) and (2), should, as far as possible, be contemporaneous

and should exist latest by the specified date. Therefore, it is revealed by the

provisions of transfer pricing that unless and until the current year data does

not gives a true and correct picture of the uncontrolled comparable price more

than one year data are not required to be considered. Only in the case when

the current year data does not give a true and correct picture and more than

one year data not being more than two years prior to the financial year can be

considered if such data reveals the fact which have an influence on the

determination of transfer pricing. In the case on hand, the assessee has not

brought on record any fact to show that the current year data are not reflecting

the correct uncontrolled comparable price. Therefore, this ground of the

assessee's appeal is dismissed.

6.1 Ground No.4 is regarding the adjustment for difference in accounting

policies, depreciation adjustment, etc.

6.2 At the time of hearing, the learned Authorised Representative of the

assessee has submitted that the grievance of the assessee is confined only to

the adjustment on account of depreciation rates and method adopted by the

15 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 assessee in comparison to the comparables. Thus the hearing on this ground

was limited only on the issue of depreciation adjustment and the other claims

have not been pressed by the assessee. The learned Authorised Representative

of the assessee has pointed out that the assessee is following a straight line

method of depreciation in comparison to the written down method adopted by

the comparables and therefore the cost of depreciation booked by the assessee

is more in comparison to the comparables and consequently an appropriate

adjustment is required under Rule 10B on this account. The learned

Authorised Representative has referred the comparable details of the

depreciation at page No.389 of the Paper Book and submitted that the average

depreciation expenses of the comparables is 7.60% to the total cost excluding

depreciation whereas the assessee's depreciation expenses to total cost

excluding depreciation is 22.85% which shows that the depreciation calculated

on straight line method is higher than the comparable companies and

accordingly a suitable adjustment is required to be made for the purpose of

determination of ALP. In support of his contention, he has relied upon the

decision of the co-ordinate bench of this Tribunal in the case of ACI Worldwide

16 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 Solutions Pvt. Ltd. Vs. DCIT in IT(TP)A No.652/Bang/2012 as well as in the case

of 24/7 Customer.com Vs. DCIT in IT(TP)A No.227/Bang/2010.

6.3 On the other hand, the learned Departmental Representative has

submitted that there is no provision under the Rules that permits any

adjustment for depreciation. Further, the assessee did not claim the

adjustment on account of depreciation before the TPO and what was claimed

by the assessee is only the capacity utilization adjustment and not the

depreciation adjustment. The CIT (Appeals) has not discussed any such

objection raised by the assessee. Thus the learned Departmental

Representative has submitted that in the absence of examination of this claim

by the TPO, it cannot be entertained at this level.

6.4 We have heard the rival submissions as well as considered the relevant

material on record. The assessee has claimed that the depreciation

expenditure of the assessee is much higher than the comparable companies

selected by the TPO for the purpose of determining the ALP under TNMM

method. The assessee has claimed to have provided the depreciation on assets

as under :-

17 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 Tangible Assets Rate of depreciation (%) Buildings 4.00 Plant & Machinery 10.00 Computers 20.00 Office Equipment 10.00 Furniture & Fixtures 10.00 Motor Vehicles 20.00

6.5 The periodical operative details provided at page Nos.4 & 5 in respect of

the depreciation expenses of the comparables as well as the assessee are as

under :-

Sl. Name of the Sales (Rs.) Expenses Dep. (Rs.) Exps. No. Comparables (Rs.) Excluding dep. (Rs.) 1. GKB 187,700,000 170,807,000 7,676,107 163,130,893 Opthalmics Ltd. 2. General Optics 91,422,000 78,629,000 8,867,000 69,762,000 (Asia) Ltd. 3. Techtran 244,900,000 210,295,630 20,250,000 190,045,630 Polylenses Ltd. 4. GKB Vision Ltd. 294,600,000 240,010,620 5,479,514 234,531,106 Average Essilor India 152,298,000 146,123,570 27,174,508 33,348,938 (without capacity adj.)

18 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 Sl.No. Name of the Cash Profits Cash Dep./ Expenses Comparables (Rs.) Profits/Sales excl. dep. 1. GKB Opthalmics Ltd. 24,569,107 13.09 4.71 2. General Optics (Asia) 21,660,000 23.69 12.71 Ltd. 3. Techtran Polylenses 54,854,370 22.40 10.66 Ltd. 4. GKB Vision Ltd. 60,068,894 20.39 2.34 Average 33,348,938 19.89 7.60 Essilor India (without 28.04 22.85 capacity adj.)

6.6 Though at the first look it is apparent that the depreciation expenditure

of the assessee is much higher than the comparable companies, however, the

exact figure has to be determined not by taking into consideration the

depreciation expenditure alone but all other related expenses like lease rental

if any paid by the comparable companies on the leased assets instead of using

its own assets as well as maintenance cost of the assets. It is pertinent to note

that there is a direct but opposite relation between the depreciation cost and

maintenance cost of the asset. When the assets are new the cost of

depreciation is more and cost of maintenance is less whereas when the

assets/machinery becomes old, the depreciation cost may be less or static but

the cost of maintenance will be definitely high. Therefore, in order to provide

19 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 any adjustment on account of differential depreciation cost, the figure of

depreciation cost alone are not enough but the composite expenditure relating

to the use of the fixed assets has to be taken into account like depreciation,

maintenance, lease rentals if any, etc. We further note that the cost of

depreciation depends on the level of automation of the manufacture process

of a particular entity which in turn reduce the other direct expenses like cost of

salary/wages. Therefore the comparison of the cost of depreciation has to be

worked out in the ratio of turnover to the cost of depreciation and other

expenditure for use of the asset/machinery. Accordingly, in the facts and

circumstances of the case when this issue has not been decided either by the

TPO or by the CIT (Appeals), we set aside the same to the record of the

TPO/A.O for working out the comparative analysis of the cost of

depreciation/use of machinery in the ratio of turnover of the assessee as well

as the comparable companies and then grant an appropriate adjustment on

account of differential ratio of the cost of depreciation including other

incidental expenses of use of machinery/fixed assets in the margins of the

comparable companies and then determine the ALP.

20 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 6.7 Ground No.5 is regarding the tolerance range of +/- 5% as per the

proviso to Section 92C(2) of the Act. This is a consequential benefit and if the

difference between mean margin and assessee's margin on the international

transactions price is within the tolerance range then benefit of the said proviso

is available to the assessee. Accordingly, we direct the Assessing Officer / TPO

to consider the same depending upon the outcome of the re-determination of

the ALP.

has been argued by the learned Authorised Representative nor it was pressed

during the hearing. Therefore, in the absence of any argument advanced by

the learned Authorised Representative or any plea for adjudication of the same,

we dismiss the Ground No.6 being not pressed.

8.1 The assessee has also raised an additional ground as under :

“a) Rejection of General Optics (Asia) Ltd. from the set of comparable companies selected by the learned Transfer Pricing Officer. b) Claim for grant of depreciation adjustment; and c) Claim for grant of capacity utilization adjustment.”

8.2 We have heard the rival submissions as well as considered the relevant

material on record. The learned Authorised Representative has submitted that

21 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 the TPO has selected two new comparables including General Optics (Asia) Ltd.

which is not functionally comparable with the assessee. He has further

submitted that this company serves the industrial consumers and he has not

indicated any personal care segment. The learned Authorised Representative

has submitted that this company has been manufacturing and exporting

precision optical system and components. It also delivers integrated solutions

to the clients in the field of design , build and test complex, opto-mechanical

and opto-electronic systems. It also caters the need of defense and armed

forces as well as atmospheric science products and space remote applications.

The learned Authorised Representative has submitted that this company is

engaged in the multiple schemes of wide range of customed precision optical

instruments, devices and components besides assemblies, sub-assemblies, etc.

which is not similar to the business activity of the assessee. He has referred the

decision of the Delhi Bench of the Tribunal in the case of Actis Advisers Pvt. Ltd.

Vs. DCIT wherein the Tribunal has held that this company serves the different

line of business and not into the sector of business like personal care but it was

engaged into the industrial usage including Defense Products, Night Vision

Equipment Products, Thermal & IR Imaging Products, Optical Test Setups

22 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 Products, Atmospheric Sciences Products, Ground Based Telescopes and Space

Applications. The learned Authorised Representative has also invited our

attention to the Annual Report of this company and submitted that apart from

the various products, this company also engaged in the R&D of manufacture of

chrome quoted subtracts, Design and development of optics for defense

equipments. He has also referred to the product description of the company

and submitted that apart from the use of optical component, this company

also used mills for the finished products. Thus the learned Authorised

Representative has submitted that this company cannot be considered as

functionally comparable with that of the assessee and the same may be

excluded by admitting the additional ground of the assessee.

8.3 On the other hand, the learned Departmental Representative has

submitted that the assessee has raised this objection only as additional ground

and functional comparability has not been examined by the authorities below

in the light of the objections raised by the assessee. He has relied upon the

orders of the authorities below and submitted that the TPO has selected this

company as it is engaged in the similar business that of the assessee.

23 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 8.4 Having considered the rival submissions and the relevant material on

record, we find that this company was selected by the TPO and included in the

list of comparables for determination of ALP. The TPO has not discussed

anything in its order regarding inviting the objections of the assessee on the

point of functional comparability of this company. Thus it appears that the TPO

has considered this company without discussing the relevant facts regarding

the functional comparability of this company. The assessee has brought before

us the relevant facts regarding the nature of the business activity of this

company as well as the products manufactured by this company. From the

Schedule 16 of the profit and loss account, the product description given

includes pre-optic component, instrument assemblies/sub-assemblies. The

raw-material consumed by this company includes glass, lenses and metals.

Thus it is clear that this company is not in the manufacturing activity of optical,

plastic lenses of human care but the product of this company is catering to the

needs of the industry, armed forces and other organizations in the field of

space applications, night vision equipments, etc. Accordingly, in the facts and

circumstances of the case, we admit the additional ground raised by the

assessee and set aside the issue of functional comparability of this company to

24 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 the record of the Assessing Officer/TPO for proper examination and

verification of the issue and decide after considering the relevant facts as well

as the objections of the assessee.

grounds is regarding the directions of the CIT (Appeals) in allowing the working

capital and risk adjustment.

10.1 We have heard the rival submissions as well as considered the relevant

material on record. The learned Departmental Representative has submitted

that when the assessee has not clarified or identified the working capital and

risk adjustment in the T.P.Study then allowing the claim of the assessee by the

CIT (Appeals) without giving an opportunity to the A.O/TPO is not permissible.

She has further submitted that in the absence of accurate computation it is not

a matter of routine to grant such adjustment. When the assessee has not

brought on record the requisite details and quantification for adjustment on

account of working capital and risk under Rule 10B then the said claim of the

assessee cannot be accepted.

10.2 On the other hand, the learned Authorised Representative has

submitted that it is the duty of the TPO to grant the eligible adjustment on

25 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 account of working capital and risk when the TPO has rejected the T.P. Study of

the assessee and adopted different method for determination of ALP. He has

further contended that since the assessee has bench mark its transactions by

adopting CPM and TPO after rejecting the CPM adopted TNMM. Therefore

there was no occasion for the assessee to give the requisite details and

quantification in the T.P. Study in respect of the working capital and risk

adjustment.

10.3 Having considered the rival submissions and the relevant material on

record, we note that the assessee has primarily bench mark its international

transactions by adopting the CPM as MAM. The TPO has applied TNMM for

determining ALP and therefore the assessee was entitled to raise the

objections as well as the other claims under the provisions of transfer pricing

including the working capital adjustment. We find that the TPO has not

discussed anything in the impugned order in respect of the working capital

adjustment and therefore this issue has not been examined by the TPO. The

CIT (Appeals) has considered the claim of the assessee and directed the TPO to

grant the working capital adjustment in para 10.2.1 and 10.2.2 as under :

26 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 “10.2.1 I have examined the TPO’s working and find that she has not provided a working capital adjustment in the computation of ALP in her order. Recently, the Mumbai Bench of the Hon'ble Tribunal in Exxon Mobil Company India P. Ltd. Vs. DCIT (15 ITR (Trib) 353) has observed :-

“The other issue is grant of adjustments, i.e. working capital adjustment and risk adjustment while arriving at the arm’s length price. In this case, the assessee in his transfer pricing study, has not made any working capital adjustment or risk adjustment. The Assessing Officer has, in fact, granted working capital adjustment. When the assessee is confronted with the possible transfer pricing adjustment due to change of some comparables and addition of certain other comparables by the TPO, this claim of risk adjustment is made by the assessee. Though, in principle, on the facts and circumstances of the case, as the assessee has not worked out the risk adjustment and as the Assessing Officer has already allowed 0.47 percent as working capital adjustment, we are of the opinion that no further adjustment is necessary.”

10.2.2 On the basis of the aforesaid line of reasoning, the TPO is directed to grant working capital adjustment, and thereafter, there is no necessity of providing any further adjustments. It is ordered accordingly.”

Thus it is clear that while issuing the directions to TPO the CIT (Appeals) has

followed the decision of the Mumbai Bench of this Tribunal in the case of Exxon

Mobil Company India P. Ltd. Vs. DCIT 15 ITR (Trib) 353. Accordingly, we do not

find any error or illegality in the order of the CIT (Appeals) in directing the

A.O/TPO to grant working capital adjustment. However, we clarify that the

assessee should furnish the relevant details and quantification for working

capital adjustment to be arrived by the TPO.

27 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 For the Assessment Year 2009-10.

“1. Assessment and reference to Transfer Pricing Officer are bad in law a) The order issued by the Deputy Commissioner of Income-tax - Circle 11(3) (‘AO’] under section 143(3) of the Income-tax Act, 1961 [‘the Act’], and the order passed by the Commissioner of Income-tax (Appeals)-IV, Bangalore [‘the CIT(A)’] under section 250 of the Act, are bad in law and on facts. Without prejudice to the to the generality of the above, the order issued by the AO is bad in law insofar as the fact that the AO did not issue to Essilor Manufacturing India Private Limited (‘the Appellant or ‘the Company’), a show cause notice as per proviso to section 92C(3) of the Income-tax Act, 1961 [‘the Act’]. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The AO erred in law in making a reference to the Additional Commissioner of Income- tax (Transfer Pricing) - I [‘TPO’], inter alia, since he has not recorded an opinion that any of the conditions in section 92C(3) of the Act, were satisfied in the instant case. The AO also erred in not following the provision contained in section 92CA(1) of the Act. The c) On the facts and in the circumstances of the case and in law, the TPO erred in not demonstrating that the motive of the Appellant was to shift profits outside India by manipulating the prices charged in the international transaction, which is a pre-requisite condition to make any adjustment under the provision of Chapter X of the Act. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. d) The order passed by the AO is without jurisdiction, inter alia, insofar as it purports to give effect to an invalid order of the TPO. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO.

2 Comparability analysis adopted by the AO/TPO for determination of the arm’s length price is bad in law a) On the facts and in the circumstances of the case and in law, the AO/ TPO erred in disregarding the benchmarking analysis and comparable companies selected by the Appellant in the transfer pricing study report maintained as per section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 [‘the

28 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 Rules’] without considering the functional and risk profile of the Company. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The AO/ TPO erred on facts and in law in rejecting one method [‘Cost Plus Method’] and selecting another method [‘Transactional Net Margin Method’] as the most appropriate method without providing cogent reasons to the Appellant for rejecting the method adopted by the Appellant. The Ld. CIT(A) erred in upholding the actions of the AO/TPO. c) The AO/TPO erred on facts and in law in conducting a fresh benchmarking analysis using non contemporaneous data and substituting the Appellant’s analysis with fresh benchmarking analysis on his own conjectures and surmises and introducing new comparable companies, without providing an opportunity to the Appellant. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO.

d) The AO/TPO erred in selecting comparables operating under a dissimilar functional profile and earning abnormal profits. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. e) The AO/ TPO erred in rejecting the segment-wise profit and loss for FY 2008- 09. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. f) The AO/ TPO erred in summarily rejecting the submission made by the Appellant in connection with Rx business and no taking note of the specific facts pertaining to the Rx Business submitted by the Appellant. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. g) The AO/ TPO erred in application of incorrect Profit Level Indicator in case of Rx segment. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO.

3 Erroneous data used by the AO/TPO

a) The AO/TPO erred in law and the Ld. CIT(A) further erred in confirming use of data, which was not contemporaneous and which was not available in the public domain at the time of conducting the transfer pricing study by the Appellant. b) The AO/TPO erred in law and the Ld. CIT(A) further erred in confirming non- application of multiple-year data while computing the margin of alleged comparable companies.

29 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 4 Non-allowance of appropriate adjustments to the comparable companies, by the AO/TPO

a) The AO/TPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (a) accounting practices, (b) depreciation adjustments, (c) research and development expenditure adjustment and (d) capacity under-utilisation adjustment between the Appellant and the comparable companies. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO. b) The CIT(A) erred in rejecting capacity adjustment citing reasons that the working capital adjustment has been allowed to the Appellant. Further, the Ld. CIT(A) erred in incorrectly observing that the Appellant had not provided workings for capacity under-utilisation adjustment in relation to comparable companies.

5 Variation of 5% from the arithmetic mean

The AO/ TPO erred in law in not granting the variation as per the proviso to Section 92C(2) of the Act. The Ld. CIT(A) erred in upholding the actions of the AO/ TPO.

6 Initiation of penalty proceedings

The Appellant submits that based on the facts and circumstances of the case, there was no basis for the AO to propose to initiate proceedings under section 271(1)(c) of the Act.

7 Relief

a) The Appellant prays that directions be given to grant all such relief arising from the above grounds and also all relief consequential thereto. b) The Appellant craves leave to add to or alter, by deletion, substitution, modification or otherwise, the above grounds of appeal, either before or during the hearing of the appeal.

30 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 c) Further, the Appellant prays that the adjustment in relation to transfer pricing matters made by the AO / TPO and upheld by the Ld. CIT(A) is bad in law and liable to be deleted.”

11.1 The grounds raised for the Assessment Year 2009-10 are common to

that of the Assessment Year 2008-09 except the Ground No.2(g) regarding

incorrect profit level indicator in case of reference (Rx) segment.

11.2 We have heard the rival submissions as well as considered the relevant

material on record. For the Assessment Year 2009-10, the assessee has carried

out the manufacturing activity in two segments i.e. (i) mass production

segment and (ii) reference manufacturing segment. While computing the ALP

and making adjustment the TPO has applied operating profit/sales in respect of

the mass production segment but applied operating profit/operating cost as

Profit Level Indicator (PLI) in the reference segment. The grievance of the

assessee is that the TPO cannot apply a different PLI in respect of different

segments of activity of the assessee when the same are the transactions with

AEs of the assessee. It is pointed out that though this issue/ground was not

raised before the CIT (Appeals) however, it is an apparent defect in the order of

the TPO in applying the different PLI in respect of different segments and

further when the TPO has applied a particular PLI for the Assessment Year

31 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 2008-09, then without giving an opportunity of hearing to the assessee, it is not

permitted to apply a different PLI.

11.3 On the other hand, the learned Departmental Representative has

objected to this ground of appeal raised by the assessee when the same was

not raised before the CIT (Appeals). The learned Authorised Representative in

rejoinder has submitted that no specific ground was raised however, the

assessee has raised this plea before the CIT (Appeals) but it was not adjudicated

by the CIT (Appeals).

11.4 Having considered the rival submissions as well as the relevant material

on record we note that though the TPO has computed both PLI i.e. the

operating margin to operating cost as well as operating margin to sales in

respect of both the segments, however, while computing the ALP and making

the adjustments the TPO has applied different PLI in respect of different

segments of activities. We further find that for the Assessment Year 2008-09,

the TPO has applied OP/Sales as PLI for the purpose of determining the ALP

and bench marked the assessee's transactions. For the year under

consideration as far as the mass production segment is concerned the TPO has

maintained the consistency of applying the PLI as operating profit to sales.

32 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 However, only in respect of reference segment, the TPO has taken the PLI as

OP to operating cost. When there is no facts or circumstances to indicate that

the change in PLI in respect of reference segments is applied to avoid distorted

results then the TPO is not permitted to apply different PLI an international

transactions which are similar except that in mass segment manufacturing of

optical plastic lenses are on standard basis without a specific personal

requirements and in the case of reference lenses are prepared as per the

specific personal requirements. Therefore, the material as well as process in

both the segments is not significantly different except the powering of the

lenses which is as per the specific requirements under the referral segments as

against the standard power of various levels in the mass production. This itself

will not justify the adoption of different PLI. Therefore, the TPO was not

justified in not maintaining the consistency of applying the PLI while computing

the ALP in respect of the international transactions. In view of the above facts

and circumstances of the case, we set aside this issue to the record of the TPO

for applying the uniform PLI as applied in the case of mass production segment

as well as in the Assessment Year 2008-09.

33 IT (T.P) A Nos.1019, 1020 & 974/Bang/2014 12. Other issues for the Assessment Year 2009-10 stand disposed off in terms

of our findings for the Assessment Year 2008-09.

appeal of the revenue is dismissed. Order pronounced in the open court on this 24th day of Feb., 2016.

Sd/- Sd/- (ABRAHAM P GEORGE) (VIJAY PAL RAO) Accountant Member Judicial Member *Reddy gp

Copy to : 1. Appellant 2. Respondent 3. C.I.T. 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard File.

(True copy) By Order

Asst. Registrar, ITAT, Bangalore