Income Tax Appellate Tribunal - Mumbai
Petro Araldite P.Ltd, Mumbai vs Department Of Income Tax
आयकर अपील य अ धकरण "के" यायपीठ मंब
ु ई म।
IN THE INCOME TAX APPELLATE TRIBUNAL "K" BENCH, MUMBAI
ी पी.एम. जगताप, लेखा सद य एवं ी वजय पाल राव, या यक सद य के सम ।
BEFORE SHRI P.M. JAGTAP, AM AND SHRI VIJAY PAL RAO, JM
आयकर अपील सं./I.T.A. No. 3782/Mum/2011
( नधारण वष / Assessment Year : 2005-06)
Dy. Commissioner of बनाम/
बनाम M/s Petro Araldite P.
Income Tax - Rg. 8(2), Vs. Ltd.,
Room No. 216-A, 782-882, Solitaire
Aayakar Bhavan, Corporate Park,
M.K. Road, 167, Guru Harigovindji
Mumbai. Marg,
Andheri Ghatkopar
Road,
Andheri (E),
Mumbai - 400 093.
थायी ले खा सं . /PAN : AAACP5685K
(अपीलाथ /Appellant) .. ( यथ / Respondent)
अपीलाथ क ओर से / Appellant by : Shri Ajeet Kumar Jain
Shri A.C. Tejpal
यथ क ओर से/ Respondent by : Shri R.C. Jain
सनवाई
ु क तार ख / Date of Hearing : 18-6-13
घोषणा क तार ख /Date of Pronouncement : 24-07-13
आदे श / O R D E R
PER P.M. JAGTAP, A.M.
ी पी.एम. जगताप, लेखा सद य :
This appeal is preferred by the Revenue against the order of ld. CIT(A) - 15, Mumbai dated 21-2-2011.
2 ITA No. 3782/Mum/20112. In ground No. 1, 2 & 3, the Revenue has challenged the action of the ld. CIT(A) in deleting the addition of Rs. 5,79,00,000/- made by the A.O. on account of transfer pricing adjustment.
3. The assessee in the present case is a company which is engaged in the business of manufacturing and dealing in basic liquid and solid resins as well as formulations. It is a joint venture company between Ciba India Limited and Tamil Nadu Petroproducts Ltd. The return of income for the year under consideration was filed by the assessee company on 28-10-2005 declaring total income at "nil" after setting off its entire profit for the year under consideration against the brought forward losses of the earlier years. During the year under consideration, the assessee had entered into the following international transactions with its Associated Enterprises (AEs):-
(1) Export of finished goods to AEs in various countries :Rs.28,60,843/-
(2) Import of raw materials from AEs in various Countries :Rs.16,15,91,463/-
(3) Management charges paid to AEs in various Countries :Rs.2,91,20,790/-
In the TP study report, TNMM was adopted by the assessee as the most appropriate method to benchmark the above transactions with its AEs and operating profit to sales was taken as PLI. All the transactions with the AEs were aggregated for benchmarking as per the said method and the following two entities were identified as comparables:-
1. Resins & Plastics Ltd.
2. Sanmar Speciality Chemicals Ltd.
4. The average PLI i.e. OP to sales of the above two comparables was worked out at 8.54% and the same being less than 12.55% of the assessee, it 3 ITA No. 3782/Mum/2011 was claimed that all the international transactions with AEs were at arm's length.
5. When reference was made by the A.O. to the TPO for determining the ALP of the international transactions of the assessee company with its AEs, the TPO found that the OP to sales at 12.55% was worked out by the assessee without deducting depreciation amounting to Rs. 6.15 crores from the operating margin. Since the depreciation was inextricably linked to the production process, the TPO included the depreciation to work out the total operating cost at Rs. 144.13 crores and after deducting the same from the total sales of Rs. 157.80 crores, he worked out the OP of the assessee (before interest and Tax) at Rs. 13.67 crores giving OP to sales at 8.63%. The TPO also carried out his own search using the relevant criteria which yielded three more comparables in addition to two comparables selected by the assessee making total comparables to five. One comparable namely Sanmar Speciality Chemicals Ltd., however, was omitted by the TPO from the set of comparables since the financial data of the said company for the financial year 2004-05 was not available as agreed even by the assessee. Accordingly, the final comparability analysis was carried out by the TPO by taking the remaining four comparables and adopting the OP to total cost as PLI as under:-
Name of the Comparable Operating profit margin using PLl Operating profit to TC% Resins & Plastics Ltd 10.90% 3M India Ltd 17.30% Elantas Beck India Ltd 17.51% Dojodwall Paper Chemicals Ltd 8.28% Average OP/TC of 13.50% comparables OP on the TC in the case of the 9.48% assessee 4 ITA No. 3782/Mum/2011 As the OP to TC of the assessee at 9.48% was lower than the average of OP to TC of the four comparables worked out at 13.50%, the assessee was called upon by the TPO to explain as to why the ALP of the international transactions with its AEs should not be determined by applying OP to TC of 13.50% and TP adjustment should not be made accordingly. The assessee, however, did not offer any explanation in the matter and keeping in view this non-compliance of the assessee, the TPO proceeded to work out the TP adjustment at Rs. 5.79 crores as under:-
Amt. in Rs.
a. Sales 157.80 Cr.
b. Total Cost (including 144.13 Cr.
depreciation)
c. Operating profit (before interest 13.67 Cr.
and tax)
d. OP/TC% in the case of the 9.48%
assessee
e. Arithmetical mean of the 13.50%
OP/TC% of the comparables
f. OP/TC as per arm's length 19.46 Cr.
margin i.e. 13.50%
g. Difference 5.79 Cr.
The addition of Rs. 5.79 crores accordingly was made by the A.O. to the total income of the assessee on account of transfer pricing adjustment in the assessment completed u/s 143(3) of the Act vide an order dated 12-12-2008.
6. Against the order passed by the A.O. u/s 143(3) of the Act, appeal was preferred by the assessee before the ld. CIT(A) disputing the addition made by the A.O. on account of transfer pricing adjustment. Before the ld. CIT(A), it was submitted on behalf of the assessee that the TPO completely failed to appreciate the difference in the capacity utilization between the assessee company and the comparable companies. It was submitted that the TPO grossly failed in not considering the adjustment on account of capacity utilization and ignored the effect of under utilization of plant by the assessee 5 ITA No. 3782/Mum/2011 which resulted in idle capacity. It was pointed out that the capacity utilization of the assessee was only 65% as against more than 80% capacity utilization in the cases of comparables.
7. The assessee also objected to the new comparable selected by the TPO and made the following submission to show that the companies selected by the TPO were actually not comparable with the assessee company:-
"3 M India Limited The company has significant related party transaction and should be rejected. Relate party transactions account for 36% of the total revenue to which the prices at which transactions are entered into may be influence. Hence, this company should be rejected and should not be taken as a comparable to the appellant.
Elantas Beck India Limited The Company has diverse operations. The company's operation have been classified into two primary segments, "Electrical Insulations" and "Engineering & Electronic Resins and Materials" as per notes to accounts of March 2005. The company also has related party transaction. Hence, this company should be rejected and should not be taken as a comparable to the Appellant.
Dujodwalla Paper Chemicals Limited The Company is engaged in trading on farm inputs. Hence, this company should be rejected and should not be taken as a comparable to the Appellant.
8. It was also brought to the notice of the ld. CIT(A) on behalf of the assessee that its sales to non-Associated Enterprises was 82% of the total sales and the A.O. computed the arm's length price of the international transactions of sales to AEs by adding the difference in the profit margin in respect of the entire sales. Relying on the various decisions of the Tribunal, it was contended on behalf of the assessee that the difference in the profit margin as worked out by the TPO should be applied only to the international transactions with AEs to work out the transfer pricing adjustment. It was contended that if the same is done by applying the average margin of comparables of 13.50% taken by the TPO to the transaction value with AEs, 6 ITA No. 3782/Mum/2011 the ALP would be within the permissible range of +/- 5%. This stand was substantiated by the assessee by furnishing the following working :-
Particulars Transaction ALP
Value
Revenue from export of finished 28.60 29.65
goods
Less: Expenditure 26.12 26.12
EBIT 2.48 3.53
EBIT on costs (as suggested by the 9.48% 13.50%
TPO)
Arm's length price of services 29.65
Application of the range ALP*0.95 28.17
Application of the range ALP*1.05 NA
Transaction value 28.60
9. After considering the submissions made on behalf of the assessee, the ld. CIT(A) identified three issues arising from the appeal of the assessee for his consideration as under:-
1. Claim of capacity utilization adjustment
2. Selection of comparables
3. Whether PLI has to be applied on a whole entity basis or AE segments only.
As regards the first issue relating to capacity utilization adjustment, the ld. CIT(A) observed that the cost incurred by any entity are of two types ; variable cost which varies directly with the production level and fixed cost which remains the same irrespective of the production level. He held that since the variable cost varies directly with the production level, its recovery remains uniform irrespective of capacity utilization whereas the fixed cost which remains the same is under recovered as a result of under utilization of capacity resulting in lower profitability. He held that there thus arises need to perform the capacity utilization adjustment and the same can be done by excluding the depreciation which represents fixed cost for the purpose of working out the profit margin of the assessee as well as comparables. He 7 ITA No. 3782/Mum/2011 therefore upheld the stand of the assessee to take EBDIT (i.e. Earning Before Depreciation Interest Tax) to sales as operating margin (PLI) for the comparability analysis. According to him, the profit before depreciation rules out any effect on the margin on account of the difference in capacity utilization and the assessee therefore was right in using EBDIT as an appropriate PLI. He noted in this regard that there was a material difference in the capacity utilization of 65% of the assessee as against 83.71% and 87.13% in the case of Rasin Plastics Ltd and 3 M India Limited taken as comparables.
10. As regards the comparables selected by the TPO, the ld. CIT(A) found merit in the contention of the assessee that one of the comparable companies namely 3M India Limited having significant related party transactions of 36% should not be taken as comparable. As regards the other two comparables namely Elantas Book India Ltd. and Dujodwalla Paper Chemicals Ltd., he again agreed with the contention of the assessee that the said two comparables taken by the TPO being functionally different should not be taken as comparable. He, therefore held that none of the said three new comparable companies selected by the TPO should be considered as comparables for determining the ALP of the international transaction of the assessee company with its AEs.
11. As regards the third issue as to whether the PLI is to be applied on entity basis or AE segment only, the ld. CIT(A) found merit in the contention raised on behalf of the assessee, which was supported by the various judicial pronouncements, that the PLI has to be applied on AE transactions only and not on total transactions as done by the TPO. He also agreed with the stand of the assessee that if it is so done, the ALP worked out of the international transactions with AE is falling within the range of +/- 5% of the actual transaction value and there was no case for making any transfer pricing 8 ITA No. 3782/Mum/2011 adjustment. Accordingly, the ld. CIT(A) deleted the addition of Rs. 5.79 crores made by the A.O. on account of transfer pricing adjustment.
12. The ld. D.R. submitted that as regards the issue of three new comparables selected by the TPO which have been rejected by the ld. CIT(A), he is placing reliance on the order of the TPO in support of the Revenue's case. He also fairly agreed that the issue as to whether the PLI of comparables is to be applied on the total transactions or only on the international transactions of the assessee with AEs is covered in favour of the assessee by the various decisions relied upon by the ld. CIT(A) in his impugned order and there is no contrary decision taking a view in favour of the Revenue on this issue. He, however, contended that if only one comparable company is finally available for the comparability analysis, the assessee cannot claim the benefit of +/- 5% adjustment as per proviso to section 92-C(2) of the Act. In support of this contention, he relied on the decision of the Tribunal in the case of General Atlanta Pvt. Ltd. vs. ACIT rendered vide order dtd. 17-5-13 in ITA No. 7638/Mum/2011 and submitted that the decision of the ld. CIT(A) in giving the benefit of +/- 5% adjustment when only one comparable was finally selected by him is contrary to the said decision of the Tribunal.
13. As regards the capacity utilization adjustment, the ld. D.R. contended that such adjustment can be allowed only after ascertaining the reason for low capacity utilization and effect thereof on the profitability. He contended that such adjustment made by the assessee and allowed by the ld. CIT(A) by taking profit margin before depreciation is not correct because depreciation is an integral part of the operating cost which cannot be ignored or excluded while computing the operating profit. He contended that this method followed by the assessee to remove the effect of capacity utilization on the profit margin is a very crude method and the ld. CIT(A) is not justified in accepting 9 ITA No. 3782/Mum/2011 the same. As regards the decision of the Tribunal in ITA No. 4459/Del/07 relied upon by the ld. CIT(A) in support of his decision on this issue, he contended that the issue involved in the said case before the Tribunal was whether the department can force the depreciation on the assessee when it was not claimed and the same being entirely different, the reliance of the ld. CIT(A) thereon is clearly misplaced. He submitted that the assessee in the present case is a manufacturing concern and depreciation therefore cannot be excluded from the operating cost for the purpose of computing the operating profit.
14. The ld. counsel for the assessee, on the other hand, strongly relied on the impugned order of the ld. CIT(A) deleting the addition made by the A.O. on account of transfer pricing adjustment. He contended that even if only one comparable case is available for the comparability analysis, the adjustment of +/- 5% is allowable to the assessee as per the proviso to section 92-C(2) of the Act which incorporates the safe harbor rule. As regards the capacity utilization adjustment, he contended that depreciation being the fixed cost was rightly excluded by the assessee from the operating cost to work out the operating profit in order to nullify the effect of difference in capacity utilization and since it was also done even in the case of comparables to work out their operating profit, the ld. CIT(A) is fully justified in accepting the PLI taken by the assessee as EBDIT. He contended that the impugned order of the ld. CIT(A) therefore calls for no interference and the same may be upheld.
15. We have considered the rival submissions and also perused the relevant material available on record. It is observed that there are four points which arise for our consideration in relation to the issue of transfer pricing adjustment made by the A.O. and deleted by the ld. CIT(A). The same are as under:-
10 ITA No. 3782/Mum/20111. Selection of comparables
2. Benefit of +/- 5% adjustment permissible as per the proviso to section 92 C(2) of the Act,
3. Application of PLI of comparables on the total transactions or on the international transactions of the assessee with AEs,
4. Adjustment for the difference in capacity utilization.
In the light of the submissions made before us as well as material available on record including the orders of authorities below, we no proceed to discuss and decide these issues.
SELECTION OF COMPARABLES
16. In the TP study report, the assessee company had identified two comparable companies namely Rasin Plastics Ltd. and Sanmar Speciality Chemicals Ltd. Since the relevant financial data of Sanmar Speciality Chemicals Ltd. for the year under consideration was not available in public domain as admitted by the assessee company also, the said company was rejected by the TPO as comparable and there is nothing in the impugned order of the ld. CIT(A) to show that this rejection was disputed by the assessee. As per the fresh search carried out by him, the TPO identified and selected three more companies as comparables viz. 3 M India Limited, Elantas Beck India Limited and Dujodwalla Paper Chemicals Limited and adding these three comparables to Rasin Plastics Ltd. which was identified as comparable by the assessee, the comparability analysis was done by the TPO working out their average OP to TC at 13.50% as against OP to TC of 9.48% in the case of the assessee. The assessee disputed these three new comparables selected by the TPO before the ld. CIT(A) by pointing out that 3 M India Limited was having significant related party transactions of 36% of its total revenue while M/s Elantas Beck India Limited and Dujodwalla Paper Chemicals Limited were functionally different. On perusal of the submissions made in this regard on behalf of the assessee before the ld. CIT(A), we find 11 ITA No. 3782/Mum/2011 that 3 M India Limited was having significant related party transactions of 36% of its total revenue and there being nothing brought on record before us to dispute this position, we are of the view that the same was rightly rejected by the ld. CIT(A) as comparable. The remaining two comparables namely M/s Elantas Beck India Limited and Dujodwalla Paper Chemicals Limited were found by the ld. CIT(A) to be functionally different from the assessee company on the basis of the submissions made by the assessee and since the ld. D.R. has not been able to rebut or controvert the findings given by the ld. CIT(A) in this context, we are of the view that M/s Elantas Beck India Limited as well as Dujodwalla Paper Chemicals Limited were rightly rejected by the ld. CIT(A) as comparables being functionally different.
Benefit of +/-5% adjustment permissible as per proviso to section 92C(2) of the Act.
17. In the present case, the TPO rejected one of the two companies identified by the assessee as comparables in the TP study report and added three more companies by carrying out fresh search as comparables. These three companies identified by the TPO were rejected by the ld. CIT(A) as comparables and since we have upheld the decision of the ld. CIT(A) on this issue, there is only one comparable finally left for the purpose of comparability analysis. The ld. D.R. has contended that there being only one company that is finally accepted as comparable, only one comparable price is available for TP study and the proviso to section 92-C(2) of the Act is not applicable. According to him, the benefit of 5% adjustment allowable to the assessee as per the said proviso thus cannot be allowed. In support of this contention, he has relied on various decisions of the Tribunal. In one of such decisions rendered in the case of Haworth (India) P. Ltd. 131 ITD 215, it was held by the Tribunal that the proviso to section 92C(2) of the Act is applicable in the case where more than one price is determined by the most appropriate method and in the case where only one price is determined by the 12 ITA No. 3782/Mum/2011 most appropriate method, benefit of 5% is not available to the assessee. The said decision of the Delhi Bench of the Tribunal in the case of Haworth (India) P. Ltd. (supra) has been followed by the Mumbai Bench of the Tribunal in the case of IIML Asset Advisors Ltd. in ITA No. ITA No. 5173/Mum/2012 wherein it was held that where only one comparable was finally selected by following the appropriate method which was acceptable to both parties and it was possible to recompute the ALP on the basis of even one comparable, the assessee would not be entitled to the benefit of 5% range as per the proviso to section 92C(2) of the Act. In the case of General Atlantic Pvt. Ltd., a similar issue arose again for the consideration of the Tribunal and vide its order dtd. 31-1-2013 passed in ITA No. 8914/Mum/2010, it was held by the Tribunal that even the language of proviso to section 92C(2) of the Act as substituted by the Finance Act, 2009 read with Explanation inserted by Finance Act 2012 with retrospective effect from 1-1-2009 makes it clear that the ALP shall be taken to be in the range of +/- 5% of more than one comparable prices and if there is only one comparable considered in the case, the benefit under the said proviso would not be available. In our opinion, this issue thus is squarely covered against the assessee by the various decisions of the Tribunal and respectfully following the same, we hold that there being only one comparable that is finally considered in the case of the assessee for the purpose of comparability analysis in order to determine the ALP, the benefit of +/- 5% adjustment as per proviso to section 92 C(2) of the Act would not be available to the assessee. The impugned order of the ld. CIT(A) taking a contrary view on this issue is therefore reversed.
Application of PLI of comparables on the total transactions or on the international transactions of the assessee with AEs,
18. It is observed that this issue is covered in favour of the assessee by the various decisions of the Tribunal which have been followed by the ld. CIT(A) while giving relief to the assessee on this issue vide his impugned order. In 13 ITA No. 3782/Mum/2011 the present case, the average profit margin of comparables was applied by the TPO to the total cost of the assessee to determine the ALP of the said transactions and based on the ALP so determined, the TP adjustment was made by him. The ld. CIT(A), however, accepted the stand of the assessee relying on the various decisions of the Tribunal cited in support that the profit margin of comparables should be applied only to the value of international transactions of the assessee with its AEs to determine the ALP of the said transactions and the TP adjustment has to be worked out on the basis of ALP so determined. In one of the decisions relied upon by the ld. CIT(A) viz DCIT vs. M/s Starlite (ITA No. 2279/Mum/06), it was held by the Tribunal that the average margin of profit of comparables determined by TNMM must be applied to the international transactions of the assessee with its AEs and not to the entire transactions at enterprise level. In another case of IL Jin Electronics (I) (P) Ltd. vs. ACIT (ITA No. 438 of 2008), the co-ordinate Bench of this Tribunal held that the A.O. was not justified in calculating the net profit on entire sales and directed the A.O. to make adjustment only for the difference in operating profit calculated on the international transactions of the assessee with its AEs. To the similar effect are the decisions of the co- ordinate Bench of this Tribunal in the case of UCB India Private Ltd. vs. ACIT (ITA No. 428 & 429 of 2007) and in the case of ACIT vs. T Two International Pvt. Ltd. (ITA No. 5644 of 2008). Respectfully following the ratio of these decisions of the co-ordinate Bench of this Tribunal, we uphold the impugned order of the ld. CIT(A) holding that the profit margin of comparables should be applied only to the value of international transactions of the assessee with its AEs to determine the ALP of the said transactions and the TP adjustment has to be worked out on the basis of ALP so determined.
Adjustment for the capacity utilization.
19. There being difference in the capacity utilization of the assessee vis-à- vis the comparables, adjustment on account of capacity utilization was 14 ITA No. 3782/Mum/2011 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 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 15 ITA No. 3782/Mum/2011 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;"
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:
16 ITA No. 3782/Mum/2011Installed capacity in Rs.10 crores Rs. 10 crores Rs. 10 crores monetary terms Capacity utilisation 50% 60% 80% Sales Rs. 5 crores Rs. 6 crores Rs.8 crores Variable overheads at Rs.2.5 crores Rs.3 Crores Rs. 4 crores 50% Fixed overheads Rs.2 crores Rs. 2 crores Rs. 2 crores Net profit Rs.0.5 crores Rs. 1 crore Rs. 2 crores Profit margin (OP/Sales) 10% 16.67% 25%
21. The above example shows that the profitability changes with the change in the level of capacity utilization with higher profitability at higher utilization and lower profitability at lower realization. This happens mainly because of higher allocation or absorption of fixed overheads at lower capacity utilization which comes down as the level of capacity utilization goes up. For instance, as given in the above example, the rate of allocation or absorption of fixed overheads to sales is 40% at 50% capacity utilization while it becomes 33.33% at 60% capacity utilization and 25% at 80% capacity utilization giving more profit margin of 16.67% at 60% capacity utilization and 25% at 80% capacity utilization as against profit margin of 10% at 50% capacity utilization. The difference in capacity utilization thus materially affects the profit margin and if there is a difference in the level of capacity utilization of the assessee and the level of capacity utilization of the comparable companies, adjustment is required to be made to the profit margin of the comparables on account of difference in capacity utilization as per clause
(e)(iii) of sub-rule (1) of Rule 10-B of the Income Tax Rules, 1962.
22. Having held that the adjustment is required to be made to the net margin of the comparables on account of difference in capacity utilisation, the next issue that arises is regarding the adoption of proper method by which the same can appropriately be made. In the present case, the assessee made this adjustment by not considering depreciation for computing its own operating profit as well as the operating profit of comparable. It was done by 17 ITA No. 3782/Mum/2011 taking EBDIT as PLI instead of EBIT. Although this method adopted by the assessee was not approved by the TPO, it was accepted by the ld. CIT(A) on the ground that the effect of difference in capacity utilization on profitability could be nullified by taking EBDIT as PLI instead of EBIT. We are unable to concur with this view of the ld. CIT(A). In our opinion, when the PLI is taken as OP to sales or OP to cost, operating profit of the assessee as well as comparable cases becomes relevant and the depreciation being very much integral part of the operating expenses of the manufacturing concern, the same cannot be excluded for the purpose of computing operating profit. Moreover, clause (e)(i) of sub Rule (1) of Rule 10-B requires that the net profit margin of the assessee is to be worked out while clause (e)(ii) of the said sub Rule requires that net profit margin of the comparables is worked out. Clause
(e)(iii), which permits the adjustments, clearly stipulates that any adjustment on account of differences affecting materially the profitability is to be made to the net profit margin of the comparables as referred to in clause (e)(ii). By taking the net profit margin of the assessee without considering the depreciation in order to make adjustment on account of difference in capacity utilization, what the assessee has sought to do is to make adjustment to the net profit margin of the assessee as referred to in clause (e)(i) of sub Rule (1) of Rule 10B, which in our opinion, is not permissible in accordance with clause (e)(iii) of sub Rule (1) of Rule 10B.
23. The question that now arises is what is the proper method of making adjustment for difference in capacity utilization within the frame work given in Rule 10B. As already discussed by us, the difference in capacity utilization affects the profitability mainly because of the difference in rates at which the fixed overheads are absorbed or allocated depending on the level of capacity utilization. The example given by us clearly depicts this position. The said example shows that the allocation of fixed overheads at the capacity utilization of 50%, 60% & 80% is 40%, 33.33% & 25% respectively resulting 18 ITA No. 3782/Mum/2011 in the profit margin of 10%, 16.67% and 25%. In our opinion, if the fixed overheads allocation or absorption of comparable is brought at the level of the assessee , it would nullify the effect of difference in capacity utilization on the profit margin. For example, if we take the profitability working at 50% capacity utilization as that of the tested party and at capacity utilization of 60% and 80% as that of the 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:-
Net profit Rs.1 crore Rs. 2.00 crores Less additional allocation of Rs. 0.40 crores Rs.1.20 crores 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%
24. The adjustment thus can be made to the profit margin of the comparables by allocating fixed overheads at the same rate at which fixed overheads are allocated in the case of the tested party. For example, in the case of a comparable having 80% capacity utilization, the rate of allocation of depreciation is 25% of the sales as against the rate of allocation of fixed overheads of 40% in the case of the tested party. If the adjustment is made in the profit margin of the said comparables by allocating more fixed overheads at 15% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the comparable would be reduced by Rs. 1.20 crores thereby giving a net profit of Rs. 0.80 crores which would bring the profitability to 10%, i.e. at par with the tested party. Similarly, if the adjustment is made in the profit margin of a comparable having 60% capacity utilization by allocating more fixed overheads at 6.67% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the said comparable would be reduced by Rs. 0.40 crores thereby 19 ITA No. 3782/Mum/2011 giving a net profit of Rs. 0.60 crores which would bring the profitability to 10% i.e. at part with the tested party.
25. Having held that the adjustment on account of difference in capacity utilization is required to be made and having explained with illustration that the same can appropriately be made by absorbing or allocating fixed overheads such as depreciation on sales of the comparable at the same rate as that of the tested party, we are of the view that such absorption or allocations of fixed overheads on operating cost instead of sales would be more appropriate as the same will eliminate the effect of difference in profit margin or difference in level of stock of finished goods, if any, of the tested party and comparables.
26. In so far the present case is concerned, it is observed that depreciation claimed by the assessee is Rs. 6.15 crores which is 4.26% of its operating cost of Rs. 144.13 crores. If the depreciation in case of a comparable is allowed at the same rate i.e. 4.26% of its operating cost instead of the actual depreciation claimed, if it is lower, this adjustment, in our opinion, will take care of difference in capacity utilization. We accordingly set aside the 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.
27. In ground No. 4, the Revenue has challenged the action of the ld. CIT(A) in deleting the addition made by the A.O. to the value of closing stock on account of Excise Duty in terms of provisions of section 145A of the Act.
20 ITA No. 3782/Mum/201128. At the time of hearing before us, the ld. representatives of both the sides have agreed that this issue is squarely covered by the decision of the Hon'ble Bombay High Court in the case of CIT vs. Mahalaxmi Glass Works Pvt. Ltd. 318 ITR 116 wherein it was held that the adjustment on account of Excise/Modvat credit is required to be made as per the provisions of section 145A of the Act in respect of closing stock as well as opening stock. In the case of Mahavir Alluminium Ltd. 297 ITR 727, the Hon'ble Delhi High Court has also taken a similar view. Respectfully following the ratio of these judicial pronouncements, we direct the A.O. to make the adjustment on account of Excise duty to the value of opening stock as well as closing stock in accordance with section 145A of the Act and make the addition, if any, to the total income of the assessee on this issue. Ground No. 4 of Revenue's appeal is accordingly treated as partly allowed for statistical purpose.
29. The next issue raised by the Revenue in this appeal is whether for the purpose of clause (iii) of Explanation 1 to section 115 JB of the Act, one consolidated figure of brought forward losses or unabsorbed depreciation for the earlier years is to be taken or the same is to be considered on year to year basis. This issue is raised by the Revenue in ground No. 5, 6 & 7 which read as under:-
"5. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not appreciating the fact that for the purpose of Clause (iii) of Explanation 1 to section 11 5JB, eligibility for deduction is to be considered on year to year basis.
6. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in holding that for the purpose of Clause (iii) of Explanation 1 to section 115JB one consolidated figure of brought forward losses or unabsorbed depreciation for the earlier years in totality is to be taken and not on year to year basis."
7. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not appreciating that the AO had rightly recomputed the Book Profit u/s.115JB by restricting the deduction of unabsorbed depreciation or brought forward loss and reduced lesser of the two from 21 ITA No. 3782/Mum/2011 the net profit to Rs.11 ,39,60,000/- instead of Rs. 13,91,13,110?- as claimed in the return of income."
30. At the time of hearing before us, the ld. representatives of both the sides have agreed that this issue is squarely covered in favour of the assessee by the decision of the Tribunal in the case of Amline Textiles (P) Ltd. vs. TPO reported in (2009) 27 SOT 152 which has been relied upon by the ld. CIT(A) in his impugned order to give relief to the assessee. In the said case, a similar issue has been decided by the Tribunal in favour of the assessee by observing as under:-
"Clause (iii) states that the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account' is to be reduces from the net profit. As per the plain language of this provision, it is noted that the word employed in the provision is the "amount" and not the "amounts" of loss brought forward or unabsorbed depreciation, whichever is less. The reference to the "amount of' brought forward loss or unabsorbed depreciation whichever is less shows the intention of the Legislature for considering one consolidated figure of brought forward loss or unabsorbed depreciation for the earlier years in totality and not on year to year basis. The use of the word "amount" in singular conveys the aim of referring it to one figure. Wherever the Legislature desired to use the word "amount" in plural, it specifically used the word "amounts" instead of the "amount" as can be seen from the heading of section 10 - ' Amounts not deductible'. From here we can easily deduce that for the purposes of clause (iii) of Explanation (1) the unabsorbed depredation for all the earlier years is to be clubbed into one amount; and the amount of brought forward loss (before depreciation) is also to be taken by summing up all the. figures of loss of earlier years, and then the lower of these two amounts is to be reduced from the net profit as shown in the profit & loss account so as to comply with the prescription of clause (iii) of Explanation (1). Similar position is coming up from the pressing into service of the word "loss"
in this clause in contradistinction to the word 'losses', as has been done in the marginal notes to sections 72,73,74,74A and 75 etc. From here we gather that by using the words 'amount' and 'loss' in this clause, the point has been made clear that it is a composite figure each of the unabsorbed and brought forward loss, that merits consideration.
Moving still further we find from the language of this clause that there is no reference to considering the brought forward loss or unabsorbed depreciation on year to year basis. There is nothing in the language of section, which could suggest, even remotely, that the Legislature intended to consider year-wise figures. If it had desired like that, then it would have been so stated in unequivocal terms in the provision 22 ITA No. 3782/Mum/2011 itself. In the absence of any specific mention in this regard in the clause, we are unable to infer such intendment. Since the language of the section is clear and does not admit of any doubt, we are not persuaded to interpret it in the way, the ld. D.R. impresses upon us to do."
31. Respectfully following the decision of the coordinate bench of this Tribunal in the case of Amline Textiles (P) Ltd. (supra), we uphold the impugned order of the ld. CIT(A) holding that the lower of the solitary figures of the unabsorbed depreciation or loss brought forward for all the earlier years taken together is to be reduced for the purposes of computing book profit u/s 115 JB of the Act. Ground No. 5, 6 & 7 of the Revenue's appeal are accordingly dismissed.
32. In the result, appeal filed by the Revenue is treated as partly allowed.
प रणामतः राज व क अपील आं शक वीकत
ृ क जाती है ।
Order pronounced in the open court on 24TH July, 2013 आदे श क घोषणा खले ु यायालय म दनांकः 24-07-2013 को क गई ।
Sd/- sd/-
(VIJAY PAL RAO) (P.M. JAGTAP)
या यक सद य JUDICIAL MEMBER लेखा सद य / ACCOUNTANT MEMBER
मंुबई Mumbai; दनांक Dated 24-07-2013.
व. न.स./ RK , Sr. PS
आदे श क त ल प अ े षत/Copy
षत of the Order forwarded to :
1. अपीलाथ / The Appellant
2. यथ / The Respondent.
3. आयकर आयु (अपील) / The CIT (A) - 15, Mumbai
4. आयकर आयु /CIT - 8 Mumbai
5. वभागीय त न ध, आयकर अपील य अ धकरण, मंुबई / DR, ITAT, Mumbai "K" Bench
6. गाड फाईल / Guard file.
ु / BY ORDER,
आदे शानसार
स या पत त //True Copy//
उप/सहायक पंजीकार (Dy./Asstt.
उप/ Registrar)
आयकर अपील य अ धकरण,
धकरण, मंुबई / ITAT, Mumbai