M/S BIESSE MANUFACTURING COMPANY PRIVATE LIMITED,BANGALORE vs. ASST.C.I.T., BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCH “ C ” BEFORE SHRI VIJAYPAL RAO, JUDICIAL MEMBER AND SHRI JASON P. BOAZ, ACCOUNTANT MEMBER I.T.(T.P.)A. No.97/Bang/2015 (Assessment Year : 2010-11) M/s. Biesse Manufacturing Co. Vs. Asst. Commissioner of Income Pvt. Ltd., Tax, Sy.No.32, No.469, Jakkasandra Village, Circle 2(1)(1), Sondekappa Road, Nelamangala Taluk, Bengaluru-1. Bengaluru RuralDistrict-562 123 PAN AACCB 7928D Appellant Respondent. I.T.(T.P.)A. No.493/Bang/2015 (Assessment Year : 2010-11) (By Revenue) Assessee : Shri K.K. Chythanya, Advocate. Revenue By : Shri Ganapati R Bhat,CIT-III (D.R) Date of Hearing : 10.09.2015. Date of Pronouncement : 6.11.2015. O R D E R Per Shri Jason P. Boaz, A.M. : These are cross appeals, one by the assessee and the other by Revenue, directed against the final order of assessment for Assessment Year 2010-11 passed under Section 143(3) rws 144C(13) of the Income Tax Act, 1961 (in short 'the Act') vide order dt.31.12.2014, in pursuance of the directions issued by the Dispute Resolution Panel (‘DRP’) under Section 144C(5) of the Act dt.21.11.2014. 2. The facts of the case, briefly, are as under :- 2.1 The assessee company is engaged in the manufacturing and trading of wood working machinery, spare parts and tools and also provides software testing, technical design and marketing services to its parent company, Biesse Spa, Italy. The assessee

2 IT(T.P)A Nos.97 & 493/Bang/2015 filed its return of income for Assessment Year 2010-11 on 14.10.2010 declaring loss of Rs.8,83,10,550. The case was processed under Section 143(1) of the Income Tax Act, 1961 (in short 'the Act') and the case was subsequently taken up for scrutiny. The Assessing Officer made a reference under Section 92CA of the Act to the Transfer Pricing Officer (‘TPO’) for determining the Arm’s Length Price (‘ALP’) of the international transactions reported by the assessee, after obtaining the approval of the CIT-I, Bangalore. The TPO passed an order under Section 92CA of the Act dt.15.1.2014 proposing a T.P. Adjustment of Rs.11,62,02,178 to the international transactions entered into by the assessee in the period under consideration. 2.2 After receipt of the TPO’s order, the Assessing Officer passed the draft order of assessment under Section 143(3) rws 144C of the Act dt.28.2.2014, wherein the income of the assessee was determined at Rs.2,78,91,628 and which included the T.P. Adjustment of Rs.11,62,02,178. 2.3 Aggrieved, the assessee filed its objections thereto before the DRP. The DRP disposed off the assessee's objections, issuing directions under Section 144C(5) of the Act vide order dt.21.11.2014. The Assessing Officer then passed the final order of assessment under Section 143(3) rws 144C(13) of the Act dt.31.12.2014 wherein the assessee's income was determined at Rs.1,84,17,896 and which included T.P. Adjustment of Rs.10,67,28,496. 3. Aggrieved by this order of assessment dt.3.12.2014 for Assessment Year 2010-11, both the assessee and Revenue have preferred appeals raising the following grounds :-

3 IT(T.P)A Nos.97 & 493/Bang/2015 3.1 Assessee's grounds of appeal are as under :- 1. The Order of the Learned DCIT in so far as it is prejudicial to the interest of the Appellant is not justified in law and on facts and circumstances of the case. 2. The Directions of the Honourable DRP in so far as the same are prejudicial to the interest of the Appellant are not justified in law and on facts and circumstances of the case 3. The Honourable DRP is not justified in upholding the action of the Learned TPO in making adjustment of Rs.10,67,28,496/- under section 92CA of the IT Act. 4. The Honourable DRP is not justified in upholding the action of the Learned TPO in considering M/s. Premier Ltd. as a comparable for the purpose of benchmarking with the Appellant, when the same does not satisfy the tests of comparability. 5. Without prejudice to the above, assuming without conceding that M/s. Premier Ltd. is a comparable Company, the Honourable DRP is not justified in failing to appreciate that only the results of engineering segment are to be considered for the purpose of benchmarking with the Appellant. 6. The Honourable DRP, having accepted that comparable net margin under TNMM is to be applied on only international transactions, is not justified in upholding the action of the Learned TPO in determining the arm’s length price in respect of manufacturing segment at the enterprise level despite Appellant having furnished the segmental results and ignoring the submission of the appellant that separate books of account are maintained in respect thereof. 7. The Honourable DRP is not justified in upholding the action of the Learned TPO in rejecting the segment data despite the Appellant having fully explained the differences observed by the Learned TPO between the revised figures and the figures in the TP study. 8. The Honourable DRP is not justified in upholding the action of the Learned TPO in computing arm’s length price under Section 92CA of the IT Act by taking incorrect average margin of 18.76% [which includes M/s. Premier Ltd., which does not satisfy the tests of comparability] as against the correct average margin of 6.40% of the comparable companies.

4 IT(T.P)A Nos.97 & 493/Bang/2015 9. Without prejudice to the above, assuming without conceding that M/s. Premier Ltd. is a comparable Company, the Honourable DRP is not justified in upholding the action of the Learned TPO in computing arm’s length price under Section 92CA of the IT Act by taking incorrect average margin of 18.76% as against the correct average margin of 8.98% of the comparable companies. 10.The Honourable DRP is not justified in upholding the action of the Learned TPO in denying adjustment in respect of under utilization of capacity while determining the ALP by perversely stating that there is no reliable information regarding the under utilization of capacity despite Appellant having furnished the Chartered Engineering Certificate and related information. 11.The Honourable DRP is not justified in perversely stating that the Appellant’s data are not reliable without finding specifically any particular item of data as being not reliable or incorrect. 12.The Honourable DRP is not justified in upholding the action of the Learned TPO in denying adjustment in respect of abnormal employee cost incurred by the Appellant while determining the ALP. 13.The Honourable DRP and the Learned TPO have failed to appreciate that as per the mandate under Second proviso to 92C(2) the Appellant is entitled for the benefit of +/-5% of the international transaction.

14.The Honourable DRP is not justified in impliedly upholding the action of the Learned Assessing Officer in denying the benefit of setoff of carried forward losses to the extent of Rs.1,16,71,624/-. 15. The Hon'ble DRP is not justified in upholding the levy of interest under sections 234B & 234D of IT Act when the conditions for levying such interest did not exist in the present case.

3.2 Revenue has raised the following grounds of appeal:-

“1. The directions of the Dispute Resolution Panel are opposed to law and facts of the case. 2. On the facts and in the circumstances of the case the Hon'ble DRP erred in holding that foreign exchange loss/gain is operating in nature when, such loss/gain through attributable to the operating activity is not derived from the operating activity.

5 IT(T.P)A Nos.97 & 493/Bang/2015 3. On the facts and in the circumstances of the case the Hon'ble DRP erred in law as well as facts in directing the TPO to consider the foreign exchange fluctuation as operating in nature while determining the margin in the case of taxpayer by applying the same principles as emerging from the orders of ITAT in the case of Sap Labs India Pvt. Ltd. 4. For these and other grounds that may be urged at the time of hearing, it is prayed that the directions of the DRP in so far as it relates to the above grounds may be reversed. 5. The appellant craves leave to add, alter, amend and/or delete any of the grounds mentioned above.”

4.1 T.P. Issues 4.1 The assessee is engaged in production and trading of wood working machinery and spare parts. The financial results of the assessee, at an entity level, were reported as under :- Particulars Amount (Rs.) Operating Revenue 25,20,15,283 Operating Cost 32,42,20,711 Operating Profit / Cost (-) 7,22,05,428 OP/OC % (-) 22.27% OP / Sales % (-) 28.65% The Segmental Results as reported in the assessee's T.P. Documentation is as under :- Particulars Manufacturing Trading (Rs.) (Rs.) Operating Revenue 17,08,11,421 9,31,37,089 Operating Cost 28,31,58,271 4,74,68,913 Operating Profit / Cost (-) 11,23,46,850 4,56,68,176 OP/OC % 48.64% -- OP / Sales % -- 49.03%

During the year under consideration, the assessee has reported the following international transactions :-

6 IT(T.P)A Nos.97 & 493/Bang/2015

Transaction Amount Rs. Purchase of components 10,45,52,930 Sale of goods 10,70,14,327 Import of finished goods 1,38,99,316 Purchase of capital goods 1,07,13,580 Receipt on account of provision of services. 2,27,95,313 Interest paid on loan (6 month Euribor + 50 basis points – 35,79,962 total interest rate is 1.46%) Reimbursement of expenses paid 2,31,51,238 Total : 28,60,06,666

4.2 In the T.P. Documentation submitted to the TPO, the assessee had mentioned that it is into both manufacturing and trading activities and that the segmental details were mentioned separately for each segment. The assessee adopted TNMM as the Most Appropriate Method (‘MAM’) to determine the ALP of the international transactions in the manufacturing segment and adopted RPM as the MAM to determine the ALP of the international transactions in the trading segment. The assessee conducted a search process and selected a set of 16 comparable companies with the average arithmetic mean margin of 7.05% on cost for the manufacturing segment. Similarly, the assessee selected asset of 8 comparables with the average arithmetic mean margin of 14.78% for the trading segment. 4.3 The assessee had attributed the losses in the manufacturing segment mainly to start up losses and under utilization of capacity and had sought adjustments for such under utilization of capacity to conclude that the international transactions of its manufacturing segment were at arm’s length. It was the contention of the assessee that the capacity utilization during the year under consideration was only 14.84% and that

7 IT(T.P)A Nos.97 & 493/Bang/2015 therefore there is a need to make adjustment for the difference in capacity utilization vis- à-vis the comparable companies while doing the comparability analysis. 4.4 The TPO, however, did not accept the contention of the assessee regarding the need for making adjustment towards capacity under utilization / non-utilisation and made the following observations :- (i) Other than general information, no evidence in support of the claim for alleged under utilization of capacity has been filed; (ii) The revised segmental financials in respect of the manufacturing and trading segments submitted in TP proceedings before the TPO were different from the details furnished in the TP Report and the assessee was not able to explain the anomalies which were pointed out in the show cause notice; (iii) Though the assessee submitted that separate set of books were maintained for trading and manufacturing activities, there is no separate reporting for trading and manufacturing segments of the tax payer. (iv) Mere filing of capacity working of plant is not sufficient for granting adjustment on account of under utilization of capacity of plant, in the absence of supporting evidence. After having made the above observations, the TPO considered the financials of the assessee at the entity level for comparability analysis under TNMM in the manufacturing segment. 4.5 After having rejected the assessee's claim for under utilization of capacity, the TPO proceeded to complete the proceedings adopting TNMM as the MAM, as was taken by the assessee. The TPO observed that the assessee had adopted multiple years’ data for computation of the average margins of the comparable companies. The TPO considered only those comparable companies whose financial data for the current

8 IT(T.P)A Nos.97 & 493/Bang/2015 year, i.e. F.Y.2009-10 was available in the TP document and he therefore accepted only 7 companies as comparable out of the 16 companies selected by the assessee. The list of 7 comparable companies selected by the TPO are as under :-

Sl.No. company PLI (OP/OC %) 1. Cmi FPE Ltd. 11.82 2. English Tools & Castings Ltd. - 15.86 3. Kabra Extrusion Technik Ltd. 17.99 4. Mitsubishi Heavy Industries 1.65 India Precision Tools Ltd. 5. Solitaire Machine Tools Ltd. 9.65 6. Lakshmi Machine Works Ltd. 9.86 7. Premier Ltd. 32.22 Average 13.57 4.6 Accordingly the TPO completed the ALP of the international transactions pertaining to the manufacturing segment as under :-

Operating Cost Rs.32,42,20,711 Arm’s Length Margin 13.57% of Operating Cost Arm’s Length Price @ 113.57% of operating cost Rs.36,82,17,461. Price Received Rs.25,20,15,283 Shortfall being adjustment u/s.92CA Rs.11,62,02,178 The aforesaid adjustment of Rs.11,62,02,178 as proposed by the TPO was incorporated by the Assessing Officer in the draft assessment order dt.8.2.2014. The assessee's objections filed before the DRP were disposed off by issue of directions under Section 144C(5) of the Act vide order dt.12.11.2014. In pursuance thereof, the Assessing Officer passed the final order of assessment under Section 143(3) rws 144C(13) of the Act dt.31.12.2014 wherein the income of the assessee was determined at Rs.1,87,17,950, in view of the T.P.Adjustment of Rs.10,67,28,496.

9 IT(T.P)A Nos.97 & 493/Bang/2015 Assessee's appeal for Assessment Year 2010-11 in IT(TP)A No.97/Bang/2015. 5.1 Aggrieved by the final order of assessment for Assessment Year 2010-11 dt.31.12.2014, the assessee has preferred this appeal before the Tribunal raising 15 grounds (supra). The grounds raised by the assessee, briefly, pertain to the following issues :- 5.1.1 Grounds S.No.1 to 3 – are general in nature and not being specifically urged before us, are rendered infructuous and are accordingly dismissed. 5.1.2 Ground Nos.4 to 5 and 8 and 9 – pertain to the selection of Premier Ltd., as a comparable by the TPO. 5.1.3 Ground Nos.6 & 7 – pertain to the applying of adjustment at the entity level instead of on the international transactions; 5.1.4 Ground Nos. 10 to 12 – pertain to adjustment for capacity under utilization. 5.1.5 Ground No.13 – pertains to the benefit of + / - 5% deduction; 5.1.6 Ground No.14 – pertains to the set off of carry forward losses; 5.1.7 Ground No.15 – pertains to the charging of interest under Section 234B and 234D of the Act. We now proceed to examine the issues raised in the assessee's appeal. 6. The Grounds at S.Nos. 1 to 3 being general in nature and not specifically urged before us, are rendered infructuous and are accordingly dismissed. 7. Ground Nos.4, 5, 8 & 9 - Selection of Premier Ltd. as a comparable. 7.1 In these Grounds, the assessee has objected to the inclusion of this company in the final set of comparables chosen by the TPO. According to the assessee, this company does not satisfy the tests of comparability and contends that merely because this company was selected as a comparable company in its T.P.Study, there is no

10 IT(T.P)A Nos.97 & 493/Bang/2015 estoppel against the assessee to consider the same as an incomparable company. It was further submitted that this company, Premier Ltd. as can be seen from its Annual Report had two segments, namely engineering segment and automotive segment and if at all it is to be considered as a comparable, then only the engineering segment of the company has to be considered for the comparability analysis. 7.2 Per contra, the learned Departmental Representative supported the orders of the authorities below in including this company as a comparable to the assessee in the case on hand. 7.3.1 We have heard the rival contentions and perused and carefully considered the material on record. Admittedly, this company was selected as a comparable company by the assessee itself in its T.P. Study as it satisfies all the criteria for comparability adopted by the assessee. In fact, the TPO has accepted all the comparables adopted by the assessee which had the current financial year data. 7.3.2 Before us, the assessee has not brought on record any material or evidence to substantiate its claim that this company is not comparable to the assessee. The assessee has also not brought on record any factors that have changed the circumstances from the time when the assessee has adopted this company as a comparable, that has since rendered this company as not comparable to it. It is nobody’s case that this company has to be taken as a comparable merely because the assessee has chosen this company as a comparable in its T.P. Study. However, the onus is upon the assessee to establish with material evidence as to how and why this company is not comparable now, when it was chosen as a comparable in its own T.P. Study. In our view, the assessee has not discharged its onus of producing any material evidence to show that this company, M/s. Premier Ltd. is not comparable to the

11 IT(T.P)A Nos.97 & 493/Bang/2015 assessee and in the absence of any evidence to establish its claim, the contentions of the assessee cannot be accepted. 7.3.3 As regards the assessee's contention that only the engineering segment of this company, Premier Ltd., has to be considered for the comparability analysis it is seen that the margin adopted by the TPO for this company is the same as that shown in the assessee's T.P. Study. Therefore, in our view, it is clear that the assessee itself has considered the comparability at the entity level rather than only at the engineering segment level as is being contended now. However, in the interest of equity and justice, it is necessary to examine this issue as to whether only the engineering segment of Premier Ltd., needs to be taken for determining its comparability. It was contended that before us that this issue was raised before the DRP, but the DRP had not adjudicated on the same. Therefore, we deem it appropriate to remand this issue to the file of the Assessing Officer/TPO for fresh consideration as to whether only the engineering segment of this company should be considered for comparability. Needless to add that the assessee shall be afforded adequate opportunity of being heard and submit details required in the matter, which shall be considered by the Assessing Officer/TPO before deciding the matter in accordance with law. Consequently, these Grounds at S. Nos. 4, 5, 8 & 9 are partly allowed for statistical purposes. 8. Ground Nos. 6 & 7 : T.P. Adjustment made at Enterprise Level. 8.1 In these grounds, the assessee assailed the decision of the TPO in determining the ALP in respect of the manufacturing segment at the enterprise level despite having the segmental details/results. It is the contention of the assessee that since separate books of accounts are maintained in respect of the two segments, the TPO ought to

12 IT(T.P)A Nos.97 & 493/Bang/2015 have considered the details related to the manufacturing segment only, for bench marking the transactions related to the manufacturing segment. 8.2.1 We have heard both parties and perused and carefully considered the material on record. It is not in dispute that the assessee had furnished the segmental details related to the manufacturing and trading segments. The TPO had pointed out certain anomalies / defects in the segmental details furnished by the assessee in the T.P. Study vis-à-vis details furnished during T.P. proceedings. The assessee was asked to explain the anomalies and it has furnished its explanation in this regard. In the show cause notice, the TPO had proposed to re-cast the segmental financials of the assessee and had proposed the margin of (-) 43.5% for the manufacturing segment and 48.5% for the trading segment. 8.2.2 After seeking the explanation of the assessee for the anomalies in the details furnished and proposing to recast the segmental details, the TPO ought to have either accepted the explanations furnished by the assessee or adopted the recast segmental details proposed by him after rejecting the explanations of the assessee. Instead of adopting either of the two, the TPO proceeded to consider the financial results at the entity level, without adducing proper reasons. In this factual matrix, we are unable to agree with the stand of the TPO. It is settled principle, upheld in several decisions, that the T.P. Adjustment has to be done only in respect of the assessee's international transactions with AEs and not on the non-AE component of the transactions. We, therefore, direct the TPO to make the adjustments only for the international transactions and not on the non-AE component of such transactions. Consequently, the Grounds raised at S.Nos.6 & 7 are allowed.

13 IT(T.P)A Nos.97 & 493/Bang/2015 9. Ground No.8 : Incorrect Margin. 9.1 In this Ground, the assessee contends that the TPO has wrongly computed the average margin of the comparable companies at 18.76% whereas the average margin of the comparable selected by the TPO works out to 6.40%. 9.2 We have examined this issue. We find from a perusal of the TPO’s order under Section 92CA of the Act, at para 10.4 / page 10 thereof, the TPO has selected 7 companies as comparables to the assessee, giving the individual margins of each company and has computed the margin of the comparable companies at 13.57%. From the details extracted by the TPO in the table of seven comparable companies at page 10 of the TPO’s order, prima facie, it appears that the average margin is certainly computed wrongly at 13.57% and rather should be 9.618%. The figures of average margin given by the assessee at 18.76% and 6.40% also, prima facie, appear to be at variance with those emerging from the TPO’s Table at page 10 of his order. In this factual matrix, we direct the TPO to examine the margins of comparable companies and compute the margins correctly after affording the assessee adequate opportunity of being heard. Consequently, this Ground is treated as allowed for statistical purposes. 10. Ground Nos. 10 to 12 - Adjustment for under utilization of capacity. 10.1 In these Grounds, the assessee has put forth its claim for adjustment on account of under utilization of capacity of the machines and in respect of abnormal employee costs. It is the contention of the assessee that its capacity utilization was only to the extent of 14.84% of its installed capacity, mainly due to the economic slow down. The TPO, however, rejected the assessee's claim of capacity under-utilisation on the ground that adequate evidence and satisfactory explanation was not provided by the assessee

14 IT(T.P)A Nos.97 & 493/Bang/2015 and that merely submitting the details of capacity is not enough to claim adjustment for under-utilisation of capacity. 10.2 Before the DRP, the assessee submitted a certificate from a Chartered Engineer giving details of the capacity to produce various types of machines and their utilization thereof. However, the DRP upheld the decision of the TPO and rejected the assessee's claim of under-utilisation of capacity. 10.3 Aggrieved by the decision of the authorities below in turning down its claim for adjustment on account under-utilisation of capacity, the assessee submitted detailed written submissions and also submitted copies of the decisions relied upon by the assessee. It was contended that the assessee is entitled for under-utilisation of capacity and the TPO has wrongly disallowed the claim for adjustment by stating/observing that there was no reliable information regarding the under-utilisation of capacity. In this regard, a Chartered Engineer certificate was submitted before the DRP; which was disregarded. In support of its contentions, the assessee placed reliance on the following decisions :- (i) DCIT V Petro Araldite P. Ltd. (2012) 148 ITD 182 (Mum-ITAT); (ii) Genisys Integrating Systems (India) Pvt. Ltd. (2012) 15 ITR (Trib.) 475 (Bangalore). 10.4.1 We have heard the rival contentions and perused and carefully considered the submissions made and material on record ; including the judicial pronouncements cited. The issue for consideration is whether adjustment for under-utilisation of capacity is allowable in the case on hand and if so, the manner of computation thereof and the quantum of adjustment.

15 IT(T.P)A Nos.97 & 493/Bang/2015 10.4.2 In terms of Rule 10B(3)(6) of the IT Rules, 1962, an uncontrolled transaction shall be comparable to an international 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. 10.4.3 The concept of adjustment for capacity under-utilisation of manpower was recognized by the co-ordinate bench of this Tribunal in the case of Genisys Integrating Systems (India) Pvt. Ltd. (supra) wherein at para 15.2 thereof it was observed that - “15.2 We agree with this contention of the counsel for the assessee. All the comparables have to be compared on similar standards and the assessee cannot be put in a disadvantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure. The Assessing Officer shall consider this fact also while determining the ALP and make the TP adjustments. With these directions, the appeal of the assessee is disposed of.” 10.4.4 The concept of under-utilisation of capacity and allowing adjustment on that count was elaborately discussed and explained by the ITAT, Mumbai Bench in the case of Petro Araldite P. Ltd. (supra) as under :- “ 19. There being difference in the capacity utilization of the assessee vis-à- vis the comparables, adjustment on account of capacity utilization was claimed by the assessee. According to the assessee, if the profit margin is taken before depreciation by adopting Earning Before Depreciation, Interest and Tax (EBDIT) as PLI, the effect of difference in capacity utilization on profit margin can be nullified. The TPO did not approve this method adopted by the assessee for making adjustment on account of capacity utilization whereas the ld. CIT(A) found the same to be acceptable holding that the under utilization of capacity results in under recovery of fixed expenses like depreciation and if the

16 IT(T.P)A Nos.97 & 493/Bang/2015 depreciation is excluded, the effect of difference in capacity utilization on profit margin can be nullified. Before we proceed to deal with the issue of adjustment for difference in capacity utilization, it is necessary first to see the procedure laid down for carrying out the exercise of comparability analysis and making suitable adjustments. This procedure as laid down in section 92-C of the Act provides that the ALP in relation to an international transaction shall be determined by any of the methods specified therein, being the most appropriate method and the manner in which the said ALP has to be determined is given in section 92-C(2) of the Act read with Rule 10B of the Income Tax Rules, 1962 in respect of each method separately. Clause (e) of Rule 10-B stipulates the manner in which the ALP in relation to an international transaction is to be determined by following the transactional net margin method as under:- “(e) transactional net margin method, by which,-

(i) the net profit margin realised by the enterprise from an international 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 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 realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (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;”

17 IT(T.P)A Nos.97 & 493/Bang/2015 20. Keeping in view the aforesaid provisions of the relevant Rule, we can now endeavor to consider how and to what extent the difference in capacity utilization affects the profit margin and how the adjustment on account of difference in capacity utilization can appropriately be made within the frame- work of Rule 10B. The issue of difference in capacity utilisation generally comes in the case of manufacturing concern and like any other business undertaking, the manufacturing concern has mainly two types of overheads i.e. fixed overheads and variable overheads. The variable overheads vary in proportion to the sales and they therefore do not have any effect on the profit margin as a result of difference in capacity utilization. The fixed overheads, on the other hand, do not vary with the volume of sales and since they remain by and large static irrespective of level of capacity utilization, the profit margin gets affected as a result of difference in capacity utilization on this count. The under utilization of capacity results in over allocation or over absorption of fixed overheads resulting into under-recovery of fixed overheads which adversely affects the profit margin. As the level of capacity utilization goes up, the rate of allocation or absorption of fixed overheads to sales comes down resulting into higher profit margin. The following simple example would further explain this position: Rs.10 crores Rs. 10 crores Rs. 10 crores Installed capacity in monetary terms Capacity utilisation 50% 60% 80% Sales Rs. 5 crores Rs. 6 crores Rs.8 crores Rs.2.5 crores Rs.3 Crores Rs. 4 crores Variable overheads at 50% Fixed overheads Rs.2 crores Rs. 2 crores Rs. 2 crores Rs.0.5 crores Rs. 1 crore Rs. 2 crores Net profit Profit margin (OP/Sales) 10% 16.67% 25%

18 IT(T.P)A Nos.97 & 493/Bang/2015 clause (e)(iii) of sub-rule (1) of Rule 10-B of the Income Tax Rules, 1962.

19 IT(T.P)A Nos.97 & 493/Bang/2015 comparables and adjust the rate of allocation of fixed overheads of the comparables in order to bring the same at par (i.e. 40% of sales) with the tested party, the resultant position will be as under:- Rs.1 crore Rs. 2.00 crores Net profit Rs. 0.40 crores Rs.1.20 crores Less additional allocation of depreciation by taking the rate of fixed overheads at 40% of sales: Net profit after adjustment Rs. 0.60 crores Rs. 0.80 crores Profit margin after adjustment 10% 10%

20 IT(T.P)A Nos.97 & 493/Bang/2015 impugned order of the ld. CIT(A) excluding the depreciation entirely for the purpose of computing operating profit and direct the A.O. to make the adjustment as given above for difference in capacity utilization after verifying the stand of the assessee that the capacity utilization of comparable company finally selected viz. Rasin Plastic Ltd. was more by 10-15% than that of the assessee during the year under consideration. Ground No. 1 of the Revenue’s appeal is thus partly allowed whereas ground No. 2 & 3 are dismissed.”

10.4.5 In the above cited case of the Mumbai Tribunal i.e. ;Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity under- utilisation can be granted. Having held that this adjustment can be granted, the Tribunal has also held that such adjustment can be made by allocating fixed overheads at the same rate as that of the tested party. Following the decision of the ITAT, Mumbai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment for capacity under- utilisation can be granted. Having so held in principle, we now examine the facts of the case on hand in the light of the above principle. 10.4.6 A perusal of the orders of the TPO and DRP show that the authorities below have not held that capacity utilization adjustment should not be granted to the assessee. Rather, it appears that they have rejected the assessee's claim of adjustment for under-utilisation of capacity on the grounds that the assessee has not furnished proper evidence to justify the claim for such adjustment. In this regard, it is seen that the assessee has furnished a Chartered Engineer’s Certificate and also a chart giving the cost break-up of the assessee and the comparable companies and the computation of adjustment therefrom. 10.4.7 A careful examination of the Chartered Engineer’s Certificate shows that the certificate essentially gives the installed capacity of the manufacturing facility and the

21 IT(T.P)A Nos.97 & 493/Bang/2015 number of machines that can be produced in the manufacturing facility. These calculations, it appears, are based on certain assumptions like, for example; i) The capacity to manufacture different machines has been worked out by considering the minimum time required for the same. The basis of this assumption has not been spelt out. ii) It has also not been spelt out as to how the minimum time required for the various machines has been worked out. iii) The capacity has been worked out by assuming 3 shifts per day i.e. it is assumed that the machine would run round the clock for all 24 hours of the day; iv) The basis for the assumption of 277 working days in a year and 80% efficiency of the machines and manpower have not been spelt out. v) Down time for repairs and maintenance has not been projected. From the above, it emerges that the capacity worked out by the assessee, is the total installed capacity. However, the optimum capacity that can be utilized is the right figure that needs to be adopted for comparability. It is well known that manufacturing industries cannot always operate to full installed capacity. It will be a wrong assumption to make that the comparable companies are all operating to their full installed capacity. The capacity to which the manufacturing units can be reasonably expected to operate is the optimum capacity and this can / will vary from industry to industry. It is essential to understand the capacity at which the comparable companies operated during that relevant period. The capacity at which the comparable companies operate has to be compared with the capacity utilization of the assessee to evaluate the under-utilisation of capacity, in the case on hand.

22 IT(T.P)A Nos.97 & 493/Bang/2015 10.4.8 From the cost sheet submitted, it is seen that the assessee has compared all the non-operating expenses of the assessee with that of the comparable companies to quantify the adjustment. This is not in keeping with the judicial decision cited above i.e. Petro Araldite P. Ltd. (supra). In this decision, the ITAT, Mumbai Bench has classified the costs into fixed and variable costs and has allowed the allocating of fixed overhead costs for the purposes of computing of the capacity utilization adjustment. The underlying principle is that if the manufacturing unit operates at less than optimum capacity, then it will affect the recovery of fixed cost, thereby affecting profitability. However, it is seen that the adjustment has been worked out by the assessee by considering all the non-operating costs also and there is no relation to the capacity utilization of the comparable companies. In view of the above, the TPO and DRP cannot be faulted for holding that the assessee has not established the quantum of capacity utilization adjustment with evidences and supporting details. In this view of the matter, we deem it appropriate, in the interest of justice and equity, to remand the issue back to the file of the TPO to work out the capacity utilization adjustment on the lines laid out in the aforesaid decision cited (supra). Needless to add, the assessee shall be afforded adequate opportunity of being heard and to make submissions / file details in this regard which shall be duly considered by the TPO before coming to a decision in the matter. Consequently, the Grounds at S. Nos. 10 to 12 on this issue are treated as allowed for statistical purposes. 11.1 In Ground No.13, the assessee contends that as per the mandate of the 2nd proviso to Section 92C(2) of the Act, the assessee is entitled to the benefit of + / - 5% while computing the ALP of international transactions.

23 IT(T.P)A Nos.97 & 493/Bang/2015 11.2 Prior to the amendment made by Finance Act (No.2) Act, 2009 and Finance Act, 2012, the proviso to Section 92C(2) of the Act provided that the ALP would be taken to be the Arithmetical Mean (‘AM’) or at the option of the assessee, a price which may vary from the AM by on account not exceeding 5% of such AM. Thus, the ALP was + / - 5% from such AM. This issue is now more of an academic nature as the IT Act, 1961 has been amended w.e.f. 1.4.2002 by the introduction of a clarificatory amendment in which Section 92CA was inserted as per Finance Act, 2012. 11.3 The new section 92C(2A) mandates that if the arithmetical mean price falls beyond + / - 5% from the price charged in the international transactions, then the assessee does not have any option referred to in section 92C(2). Thus, as per the above amendment, it is clear that the + / - 5% variation is allowed only to justify the price charged in the international transactions and not for adjustment purposes. The aforesaid amendment has settled the issue and accordingly the 5% benefit is not allowable in the assessee's case. The various judicial decisions cited pertain to the period prior to the retrospective amendment in section 92C(2A) of the Act and are not applicable to the facts of the assessee's case. In view of the amendment brought about therein by Finance Act, 2012, this ground raised by the assessee is not maintainable and is accordingly dismissed. 12. Ground No.14 : Set off of carry forward losses. 12.1 In this Ground, the assessee contends that it has been wrongly denied the benefit of set off of carried forward losses to the extent of Rs.1,16,71,624 by the authorities below. Since we find, from a perusal of the orders of assessment, that this issue has not been addressed by the Assessing Officer, we direct the Assessing Officer to examine and verify the assessee's claim for set off of carried forward losses in

24 IT(T.P)A Nos.97 & 493/Bang/2015 accordance with law, after affording the assessee adequate opportunity of being heard in the matter. 13. In Ground No.15, the assessee denies itself as being liable to be charged interest under Section 234B and 234D of the Act. The charging of interest is consequential and mandatory and the Assessing Officer has no discretion in the matter. This proposition has been upheld by the Hon'ble Apex Court in the case of Anjum H Ghaswala (252 ITR 1) and we, therefore, uphold the action of the Assessing Officer in charging the said interest. The Assessing Officer is, however, directed to recompute the interest chargeable u/s. 234B and 234D of the Act, if any, while giving effect to this order. 14. In the result, the assessee's appeal for Assessment Year 2010-11 is partly allowed for statistical purposes. Revenue’s appeal for Assessment Year 2010-11 in IT(TP)A No.493/Bang/2015 15. The Grounds at S.Nos.1, 4 & 5 are general in nature and therefore no adjudication is called for thereon. 16. Ground Nos.2 & 3 : Treatment of Foreign Exchange Gain as operating in nature. 16.1 In the Ground Nos.2 and 3, Revenue contends that the DRP erred in holding that foreign exchange gain/loss to be operating in nature without ascertaining the nexus between the forex gain with the business activity of the assessee following the decision of the co-ordinate bench in the case of SAP Labs India Pvt. Ltd. (2010) 6 ITR (Trib.) 81 (Bangalore-ITAT). and without appreciating that this gain is not derived from the operating activity of the assessee. The learned Departmental Representative was heard in support of the grounds raised. 16.2 Per contra, the learned Authorised Representative supported the impugned order of the DRP in holding foreign exchange gain/loss to be part of the operating

25 IT(T.P)A Nos.97 & 493/Bang/2015 revenue for the purpose of computing the assessee's margin for comparison with the margin of the comparable companies. The learned Authorised Representative contended that revenue’s appeal on this issue is liable to be dismissed as the issue of foreign exchange gain being part of the operating revenue’s for the purpose of computing the assessee's margin has been held in favour of the assessee by the decision of the co-ordinate benches of this Tribunal, inter alia, in the case of NXP Semi Conductors India Pvt. Ltd. in IT(TP)A No.1662/Bang/2014 dt.12.8.2015 which has followed the decisions of earlier co-ordinate bench of this Tribunal in the case of Triology E-Business Software India Pvt. Ltd. (supra) and Sap Labs India (P) Ltd. (2011) 44 SOT 156 (Bang). 16.3 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial decisions cited and placed reliance upon. We observe that it has not been disputed that the foreign exchange gain/loss has arisen as a consequence of the realization of the consideration in the course of business operation for rendering software development of the assessee and therefore there is no reason for its exclusion from the operating revenues for the purpose of calculating the operating margin of the assessee. The DRP in its order at para 3.2 thereof, following the order of the co-ordinate bench of this Tribunal in the case of SAP Labs India Pvt. Ltd. (supra) has held and directed the A.O. to consider foreign exchange fluctuation as operating in nature in respect of the assessee as well as the comparable companies while determining the margins in the case on hand. We find that this proposition has been upheld by a co-ordinate bench of this Tribunal in the case of NXP Semi Conductors India Pvt. Ltd. in IT (TP) A No.1662/Bang/2014 dt.12.8.2015 wherein at para 4.3 thereof it has been held as under :-

26 IT(T.P)A Nos.97 & 493/Bang/2015 “ 4.3 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial decisions cited and placed reliance upon. We observe that it has not been disputed that the foreign exchange gain/loss has arisen as a consequence of the realization of the consideration for rendering software development services and therefore there is no reason for its exclusion from the operating revenues for the purpose of calculating the operating margin of the assessee. We find that this proposition has been upheld by a co-ordinate bench of this Tribunal in the case of Amba Research India Pvt. Ltd. in IT(TP)A No.1376/Bang/2014 dt.17.4.2015 wherein at para 5.7 thereof it has been held as under :- “ 5.7 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial decisions cited and placed reliance upon. We observe that it has not been disputed that the foreign exchange gain has arisen as a consequence of the realization of the consideration for rendering ITES services and therefore there is no reason for its exclusion from the operating revenues for the purpose of calculating the operating margin of the assessee. We find that this proposition has been upheld by a co-ordinate bench of this Tribunal in the case of Mindteck (India) Ltd. in IT(TP)A No.70/Bang/2014 dt.21.8.2014 wherein at para 11 thereof it has been held as under :- “11. We have considered the rival submissions. It is not disputed by the Revenue that the foreign exchange fluctuation has arisen as a result of the realization of the consideration for rendering software development services. It is therefore incurred in the normal course of business and therefore there is no reason why it should be excluded from determining the operating revenue for the purpose of calculation of operating margin. In our view, the analogy drawn by the DRP regarding exclusion of interest expenses while computing operating margins is not proper. In our view, foreign exchange gain on realization of consideration for rendering software development services should be regarding as part of the operating revenue. Following the decision of the ITAT, Bangalore Bench in the case of SAP Labs (supra), we hold that the operating revenue for the assessee be computed by including the foreign exchange gain.” Following the decision of the co-ordinate benches of this Tribunal in the case of Sap Labs India (Pvt.) Ltd. (supra), Triology E Business Software India Pvt. Ltd. (supra) and Mindteck (India) Ltd. (supra), we hold that operating revenue should be computed by including the foreign exchange gain. Consequently, the grounds at S.Nos.2 to 4 raised by revenue are dismissed.” Following the decision of the co-ordinate benches of this Tribunal in the case of Sap Labs India (Pvt.) Ltd. (supra), Triology E Business Software India Pvt. Ltd. (supra), Mindteck (India) Ltd. (supra) and Amba Research India Pvt. Ltd. (supra), we hold that operating revenue should be computed by including the foreign exchange gain/loss. Consequently, the grounds at S.Nos.2 to 4 raised by revenue are dismissed.”

27 IT(T.P)A Nos.97 & 493/Bang/2015 16.4 Following the decision of the co-ordinate benches of this Tribunal in the cases of Sap Labs India (Pvt.) Ltd. (supra), Triology E Business Software India Pvt. Ltd. (supra), Mindteck (India) Ltd. (supra) and NXP Semi Conductors India Pvt. Ltd. (supra), we hold that operating revenue should be computed by including the foreign exchange gain which is clearly arising out of the export business; is related to the profit and loss account and is in the revenue field. However in the case on hand, the assessee has stated that the foreign exchange gain is arising out of restatement of receivables/payables which are Balance Sheet items and we do not find any clear finding in this regard in the orders of the authorities below. Therefore, we remand the issue back to the Assessing Officer /TPO to examine / determine whether the entire foreign exchange gain has arisen out of the export business of the assessee and thereafter to that extent treat the same as operating in nature while computing the margins of the assessee and the comparable companies after affording the assessee adequate opportunity of being heard and submit details submissions in the matter. 17. In the result, Revenue’s appeal for Assessment Year 2010-11 is treated as partly allowed for statistical purposes. 18. To sum up, Revenue’s appeal for Assessment Year 2010-11 and Assessee's cross appeal are both partly allowed for statistical purposes. Order pronounced in the open court on 6th Nov., 2015.

Sd/- Sd/- (VIJAYPAL RAO) (JASON P BOAZ) Judicial Member Accountant Member *Reddy gp