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Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा सद� राजे� के अनुसार PER RAJENDRA, AM- Challenging the order dated 11.09.2013 of the CIT(A)-15,Mumbai,the assessee has filed the present appeal raising various Grounds of appeal
.Assessee-company, engaged in the business of manufacturing/exporting diamond studded jewellery, filed its return of income on 24.09.2009.During the assessment proceedings, the AO found that the assessee had entered into following International Transactions (IT.s) with its Associate Enterprises(AE.s): SN. Transaction Amount(Rs.) Method
1. TNMM Sale of Diamond studded jewellery (Receipt) 16,31,34,795/-
2. Purchase of Cut and Polished Diamond (Paid) 90,46,660/- TNMM
3. Purchase of Findings (Paid) 8,20,390/- TNMM 2.He further found that the assessee had adopted TNMM method as most appropriate method(MAM)for determining the Arm’s Length Price(ALP)of the transactions,that it had selected three comparables.So,he made a reference to the Transfer Pricing Officer(TPO)to determine the Arm’s length Price(ALP)of such transactions.After receiving the order of the TPO the AO issued a draft order to the assessee who opted not to challenge it before the DRP.The AO completed the assessment u/s.143(3) r.w.s. 144C(3)&(4) of the Act on 27.02.2012 determining the income of the assessee at Rs.NIL, after considering the brought forward losses of earlier years. 3.First ground of appeal is about TP adjustment of Rs.3.59 Crores.During the TP proceedings the TPO observed that the assessee had only one AE. i.e.M/s. Fantasy Diamond
7066/M/13(08-09)Radhashir jewellery Corporation,USA,that it was primarily engaged in purchase and Sale/ distribution of jewellery products in USA to the major USA wholesalers,that the total turnover of the assessee for the FY. 2007-08 was Rs.16.31 Crores,that Operating Profit was Rs.(-) 0.46 Crores,that PIL (OP/Sales)for the year was 2.83% and OP/TC was (-)2.75%. After analysing the available material,the TPO observed that all the transactions were of the same segment of manufacturing of jewellery and the assessee had bench-marked them together.PLI of three comparables namely Goldiam International Ltd.(GIL),Neogem India Ltd.(NGL),Shantivijay Jewellery Ltd.(SJL) was taken for bench-marking.The assessee furnished a detailed working of PL(OP/TC) after claiming underutilisation of capacity.The TPO did not approve the method of bench marking and held that the perusal of the month-wise sales summary,provided by the assessee, revealed that the sales were made in each and every month starting from July 2007,that sales were not made only for first 3 months of FY.2007- 08,that it had not quantified the effect of underutilisation in the comparable companies. 3.1Considering the inadequacy of reasonable numbers of comparables,the TPO provided a set of twelve comparables to the assessee.The set of the 12 comparables and the three comparables selected by the assessee were taken for benchmarking which had a common comparable namely,Shantivijay Jewels Ltd.The assessee raised various objections to the proposed comparison.It was argued that assessee was having an unit, wherein the production started in the month of May, 2007 and the sales started from the month of July,2007,that the effective sale commensurated with production base only in three months of the year under appeal, that it had achieved sales of obesity two Crores in the subsequent financial year as against the sale of Rs. 16.13 Crores in the year under consideration.But,the TPO rejected contentions raised by the assessee. He excluded Asian Star Co.Ltd.and Goldiam International Ltd.From the list of comparables,the revised PLI was worked at 7.46%.The TPO held that the arithmetic mean of 12 comparable companies was more than the assessee’s PLI of - 11.96%,that the transactions of the assessee had not been entered at a LP. The TPO, accordingly, benchmarked the transactions by taking PLI (OP/TC) at 7.46% of the 12 comparables and worked out an adjustment of Rs. 3.59 Crores.
4.Aggrieved by the order of the AO,the assessee preferred an appeal before the First Appellate Authority(FAA) and contended that the TPO had compared results of selected 12 comparables without bringing them on the same platform, that he had ignored the fact that assessee was a new unit and had started selling the goods from the month of June,2007 only,
7066/M/13(08-09)Radhashir jewellery that it had achieved sales of Rs. 62 Crores in the next assessment year after stabilisation of processes and marketing on the same assets and expenses base,that the increase in expenses was mainly because of increase in direct expenses due to increase in volumes, that the assessee was working on almost the same asset base in both the years, that with almost the same base it had achieved fourfold increase in sales and tenfold increase in gross profit which had increased from Rs.49.52 Crores to Rs.510.29 Crores,that the profit on materials consumed was 9.80% and 10.70% for the AY.2008-09 and AY.2009 -10 respectively,that the difference in GP at the rate of 3.04% and 8.21% for the year under appeal and the AY. 2009- 10 could be explained as manufacturing expense for the year under appeal,that it had incurred loss during the year because of expenses incurred by it which were to commensurate with the sale of almost Rs.60 Crores but could achieve the sales of Rs.16 Crores only, that the basic intention underlying the TP provisions was to prevent shifting out profits by manipulating prices charged or paid in international transactions and evading the country’s tax base,that it was a manufacturer of diamond studded jewellery products,that its manufacturing units were situated in special economic zone, that it was entitled to claim deduction under section 10AA of the Act on the profits earned by it, that it was entitled to 100% tax deduction on the profits made on its business activities, that the tax incidence in the USA on the business profit was as high as 40%, that there was no incentive to the assessee to transfer profit to higher tax jurisdiction such as USA compared to India especially when the assessee enjoyed deduction under section 10AA of the Act. The assessee also stated that it had complied facts based on which it deserved adjustment for working capital, that such compilation was under finalisation, that full set of annual accounts was not available in respect of two comparables, ,that there was a substantial underutilisation of capacity as compared to full capacity and expenses incurred, both fixed and variable,were almost at the same level in the year under consideration(year of underutilisation of capacity) and next assessment year(year of full utilisation of capacity),that comparing old established companies having substantial capital employed in the business with the assessee that started business in the year under appeal was not justified,that the comparable companies were holding substantial inventory, that they were renting high credit period to the buyers as compared to the assessee, that when large inventories were held the assessee would make extra profit. The assessee submitted the computation of month wise production and other financial ratios for the year under consideration and the next year and argued that operating loss incurred by it was not on account of content of raw material utilised and the sale price of the products sold to AE,that
7066/M/13(08-09)Radhashir jewellery the loss was primarily due to this proportionate manufacturing and administration expenses and depreciation as compared to production and sales achieved by the assessee.
4.1After considering the submissions of the assessee,the TPO held that the subsequent year's data could not be considered for benchmarking the transactions as provided in Rule 10B(4)of IT Rules,that as per details submitted the sales started from the month of July itself,that in the month of February the sales in next year had gone down to Rs.84.95 lacs as compared to the year under consideration of Rs. 192 lacs,that there was no force in the argument of the assessee that the sales in each month picked up in the subsequent year.
4.2The FAA further held that the TPO had determined ALP of the ITs of the assessee as per the provisions of section 92C(1) and 92C(2) of the Act that as per the TP Regulations of India there was no encumbrance either on the TPO or the AO to prove that there was any manipulations of the prices which had led to shifting of the profits outside India,that the TP Regulations had been brought into the statutes to prevent the erosion of the tax base of the country, it was not the case of the assessee that it had not under taken any IT.s which would fall within the meaning of section 92 of the Act or that the TP regulations of India were not applicable,that the assessee itself had undertaken benchmarking process and had arrived at the conclusion that its IT.s were at arm's length,that the subsequent year's data could not be considered for benchmarking the transactions as provided in Rule 10B(4) of IT Rules, that dividend distribution tax u/s.115-O was applicable to such profits,that in a case where a subsidiary had accumulated higher profit corresponding dividend distribu -tion tax u/s. 115-O would be higher and vice-versa,that lower accumulated profit by way of transfer pricing of services would help such companies in saving tax in India and thus leading to erosion of tax- base in India,that in such cases provisions of section 92 would be applicable,that any adjustment which way be permitted would only be in accordance with the Rule 10B(1)(e) which is in respect of Transactional Net Margin Method (TNMM),that the assessee in its submission had contended for certain adjustments.
4.3.Before us,the Authorised Representative(AR)argued that the assessee had computed its operating margin for the year under consideration after excluding fixed cost attributable to start-up phase and underutilised production capacity,that it started commercial operations from 26.04.2005,that it was required to incur certain fixed costs,that being the initial year, assessee was not able to generate the required sales so as to recover the fixed costs incurred 4
7066/M/13(08-09)Radhashir jewellery by it,that it was not able to utilise the production capacity to its optimum level during the year,that it utilised only 21% of its production capacity and therefore it incurred a loss,that the incurrence of start-up costs and under utilisation of capacity in the initial year had resulted in loss and the reason for such loss could not be attributed to pricing of its products sold to the AE.s.,that the comparable cases selected by the TPO were units which were already established in market who did not have such factors,that the revenue authorities had not accepted the aforesaid stand of the assessee,.He relied upon the cases of M/s Fiat India Pvt. Ltd.(ITA/1848/Mum./2009 dated 30. 04.2010); Skoda Auto India (P.) Ltd.(122 TTJ 699)Egain Communication (P.) Ltd.(118 TTJ 354);Amdocs Business Services (P.) Ltd.(26 taxmann.com 120); Schefenacker Motherson Ltd.(123 TTJ 509) .
4.3.1The Departmental Representative(DR)supported the order of the FAA and stated that the FAA had extensively dealt with the issue of under utilization of capacity of the assessee .He referred to the case of the Delhi Bench of the Tribunal delivered in the case of Haworth (India) P. Ltd.(131 ITD 215).
5.We have heard the rival submissions and perused the material before us.We find that the assessee had started its business for the year under appeal,that the TPO/AO made adjustment of Rs.3.59 Crores,that it had argued before the FAA that benefit of underutilisation of capacity should be allowed before making any adjustment. 5.1It is a fact that the TPO had compared results of selected 12 comparables without bringing them on same platform,that he ignored the fact that the assessee was a new unit, that effective sales happened only in 3 months of the calendar year 2008, i.e.September,October and November of the year under.In our opinion,for making TP adjustments,as per the provisions of section 92 of the Act,comparison has to be made between the two equals.An assessee who starts business in a particular year cannot be compared with the assessees who are doing business for many a years.Even if comparison of such an assessee has to be made ,then it has to be seen that both are at same level.No assessee can achieve full capacity of production for an AY.,if it starts business in the later part of that year.In the case under appeal major sales are not throughout the whole year,whereas the expenses incurred by it are same or almost the same as compared to the expenses of the next year.It is a fact that the assessee had achieved sales of Rs.62 crores in next AY.It is not a mere coincidence.The above results for the next year were achieved because processes got stabilised by that time though the 7066/M/13(08-09)Radhashir jewellery assessee was working on almost the same Asset Base in the both the years.It is a fact that assessee had used only 21% of its total production capacity.The Annual Accounts of the assessee-company (page 51 of the Paper Book) proves the above facts and it is also true that the fact has not been disputed by the departmental authorities. 5.2We have taken notice of the following working of gross profit, submitted by the assessee,for both the AY.s.:
AY.2008-2009 AY.2009-10
16,31,34,795 62,18,76,931 Sales Material Consumed 14,71,46,511 55,53,26,673 6,65,50,258 Profit on materials consumed 1,59,88,284 Percentage 9.80% 10.70% Manufacturing Expenses 1,10,35,488 1,55,20,943 Gross Profit 49,52,796 5,10,29,315 Percentage 3.04% 8.21% An analysis of the table indicates that the profit on materials consumed was 9.80% for AY.2008-09 and 10.70% for the AY.2009-2010.It is a vital factor to decide the issue before us.In our opinion,the assessee had suffered loss during the year because of expenses incurred by it commensurated with sales of the next year (Rs.60Crores),whereas it could achieve sales of Rs. 16 Crores only in the year under appeal.It is also a fact that availability of working capital and size of inventories affect the profit of the companies.Business is not a simple arithmetical formula-so many factors affect the final outcome i.e.the profit.Therefore,for arriving at fair and just conclusion such facts cannot and should not be ignored-otherwise an absurd and distorted result will follow.The basic purpose of taxation proceedings,including the TP proceedings,is to determine the due taxes for the Sovereign.Without considering all the relevant and material facts due taxes cannot be assessed.In the case before us, the basic fact of capacity-underutilisation has been ignored.Besides,depreciation would also have bearing on taxable income. Even in cases of domestic companies it plays a vital role.In the initial years most of the manufacturing companies suffer losses because of high depreciation.In short, for determining fair TP adjustments, the TPO/FAA should have considered these vital factors and given finding.Along with the depreciation certain fixed operating costs,like Factory Rent,Testing Research & Development Cost etc.would have to be incurred irrespective of the level of production.Respectfully following the cases relied
7066/M/13(08-09)Radhashir jewellery upon by the AR(para 4.3 of our order),we hold that appropriate adjustment has to be allowed while computing the net margins in the case of tested party also to facilitate comparability analysis.Therefore,in our opinion,in the interest of justice, matter should be restored back to the file of the AO/TPO for fresh adjudication who would consider the capacity- underutilisation factor along with the other factors for determining TP adjustments. Besides, two of the comparables objected by the assessee needs to be reconsidered to find as to whether they are fair comparables.Proverbial apple has to be compared with an apple.The TPO/AO would decide the issue after affording a reasonable opportunity of hearing to the assessee.
5.3.With regard to matter of Haworth (India) P. Ltd. (supra),relied upon by the DR we would find that the assessee had computed its margin after claiming adjustment for capacity utilisation,that it had adopted the TNM method for the purpose of computing its ALP.,that it had claimed that capacity utilisation of comparables was to the extent of 70% which was an assumption made due to non-availability of the required details of the comparable cases,that the TPO had rejected the adjustment on the ground that assessee had not submitted any evidence for assuming the capacity utilisation of the comparables,that the data relied upon by the assessee was found to be either unreliable or incorrect,that considering those facts the Tribunal came to conclude that it did not furnish sufficient evidence with regard to the capacity-utilisation of the comparable cases.In our opinion,facts of the case before us,are totally distinguishable from the facts of Haworth (India) P. Ltd. (supra).The TPO had not challenged the fact that the assessee was functioning at 21% of the capacity during the year under appeal.So,the case of no help to decide the issue.Ground no.1 is decided in favour of the assessee,in part.
6.Second ground of appeal is about difference in closing stock.During the assessment proceedings,the AO found that the Auditors have provided quantitative details of closing stock in respect of Gold under: Particulars Quantity(Gms) Value Rate per gram Opening Stock NIL NIL NA Purchases 40000 39499258 987.48 Closing Stock 4572 2435941 532.80 He observed that the assessee was having closing stock of gold of 4572 grams having value of Rs.24,35,941/-.Taking this value and quantity of 4572 grams,the AO observed that gold had 7066/M/13(08-09)Radhashir jewellery been valued at 532.80 per gram,that the value shown by the assessee of gold was abnormally below the market value of Rs 1,213/- per gram as on 31.03.2008.He asked the assessee to provide the details and explanation for the difference in valuation.
6.1The assessee,vide its letter dated,19.12.2011,provided the explanation and contended that closing stock of gold had been taken at 4572 gms.,instead of correct figure of 2033 gms.,that it was having closing stock of gold alloyed of 2539 gms.,that same was shown in work-in- progress(WIP)of closing stock,that same closing stock quantity was included in the closing stock of raw material due to typographical error.After considering the submissions of the assessee,the AO observed that the explanation provided by the assessee showed that it was caught on the wrong foot,that on a inquiry by him it submitted that quantitative details provided in the Audit Report u/s 44AB was incorrect,that the explanation was unbelievable, fabricated and was an after-thought.Accordingly, the AO took the value of closing stock of gold of 4572 grams at Rs.55,45,836/- applying the market rate of Rs.1,213 per gram.As a result an addition of Rs.31,09,895/-was made being difference between value of closing stock shown by the assessee and value of closing stock computed as above.
6.2.During the appellate proceedings,before the FAA,the assessee submitted that the AO had made the addition without considering the details submitted by it and he did not make any attempt to analyze the same,that the reliance of the AO on the decision of the Hon'ble Supreme Court in the case of British Paints India Ltd. (188 ITR 44) was out of context,that from the statements submitted to the AO,vide letter dated 19.12.2011,the assessee had already added the overhead charges in valuing the closing stock of Finished Goods and Work-in-progress.
6.3After considering the submissions of the assessee,the FAA held that closing stock of gold of 4572 grams which was valued at Rs.532.80 per gram against the market price of Rs.1213/- per gram as on 31.03.2008,that the assessee had explained before the AO that it was due to typographical error in the audit report,that part of it was alloy and not gold,that the said contention of the assessee was not supported by any documentary evidence,that the contention of the assessee on account of difference in valuation stock of gold,amounting to Rs.31,09,895/-,was not acceptable.Finally, he upheld the order of the AO.
7066/M/13(08-09)Radhashir jewellery 6.4.Before us, the AR stated that there was a bonafide mistake in the original audit report, that the revised audit report was made available to the AO, the AO could have made further enquiries about raw material, without any further verification the AO made the additions. DR supported the order of the AO and the FAA.
6.5.We have heard the rival submissions and perused the material before us.We find that an addition of Rs.31,09,895/-was made by the AO on account of being difference between value of closing stock shown by the assessee and value of closing stock computed by him,that the assessee had argued that there was a typographical mistake in the audit report,that a revised report was submitted that indicated the mistake committed while filing the original return.In our opinion,the AO should have made further inquiries and should have examined who had issued two audit reports to find out the truth of the claim of the assessee that there was mistake in the first audit report.Audit reports are not simple piece of papers-they are prepared and signed by the professionals.Therefore,the AO should have verified the facts before making an addition.We are restoring the issue to the file of the AO,as we are of the opinion that matter needs verification about the claim made by the assessee.We direct the AO to afford a reasonable opportunity of hearing to the assessee.Second ground is partly allowed.