Income Tax Appellate Tribunal - Bangalore
M/S Skf Technologies India Pvt Ltd , ... vs The Commissioner Of Income Tax ... on 15 February, 2019
IN THE INCOME TAX APPELLATE TRIBUNAL
BANGALORE BENCHES "B", BANGALORE
Before Shri N.V.Vasudevan, VP & Shri B.R.Baskaran, AM
IT(TP)A No.341/Bang/2014 : Asst.Year 2004-2005
M/s.SKF Technologies India The Dy.Commissioner of
Private Limited (Formerly Vs. Income-tax, Circle 12(3)
known as SKF Sealing Bangalore.
Solutions Private Limited
Sealing Solution Business
Unit, Plot No.36, Part-37, 38,
39, KIADB New Layout
Nanjangud Road, Kadakola
Village, Mysore-571 311.
PAN : AAACC4393D.
(Appellant) (Respondent)
Appellant by : Shri Ketan K.Ved, CA
Respondent by : Shri R.N.Siddappaji, Addl.CIT
Date of
Date of Hearing : 13.02.2019 Pronouncement : 15.02.2019
ORDER
Per B.R.Baskaran, AM :
The appeal filed by the assessee is directed against the order dated 19.03.2014 passed by learned CIT(A)-IV, Bangalore, and it relates to the assessment year 2004-2005. The assessee is aggrieved by the decision of the learned CIT(A) in confirming the addition of Rs.72.73 lakhs relating to transfer pricing adjustment made in respect of finished goods exported to the Associated Enterprises (AE) of the assessee.
2. The assessee herein is a subsidiary of SKF Inc. US, which is a leading global supplier for products, sales and 2 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
services for rolling bearing and seals business. During the year under consideration, the assessee had entered into international transaction with its AE in the form of import of raw materials, finished goods & capital goods; receipt of services; reimbursement of expenses and export of finished goods. The dispute herein is with regard to the ALP adjustment made in respect of export of finished goods (referred as "manufacturing segment"). The assessee had adopted TNMM method as most appropriate method and operating profit margin to sales ratio as PLI.
3. The OP/Sales in the manufacture segment before depreciation was computed at (-) 12.70% . The company had selected four comparables, whose average PLI was computed at 9.23%. However, in the TP Study, the assessee re- computed the average margin of comparable by excluding "depreciation" and "overheads". Similarly it also re-computed its own margin in the same way. The Ld A.R explained the rationale behind the above said claim of the assessee. It was submitted that the capacity utilization of the assessee was lower during the year under consideration. Irrespective of the capacity utilization, it had to incur overheads and provide for depreciation and both these expenses have reduced its profit margin. It was submitted that the comparable companies had higher capacity utilization. Accordingly it was submitted that the depreciation and overheads were excluded, so that a meaningful comparison could be made. The re-computed PLI of "comparables" worked out to 24% and its own PLI worked out 25%. Accordingly, the assessee claimed that the 3 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
international transactions in manufacturing segment are at arm's length. The TPO, however, did not agree with the contentions of the assessee. However, the TPO agreed to exclude depreciation and accordingly computed PLI of comparables at 14.75%. By applying the same, the TPO made an adjustment of Rs.72.73 lakhs. The same was confirmed by the learned CIT(A).
4. The learned Counsel appearing for the assessee submitted that the assessee has sought for exclusion of depreciation and fixed cost since the capacity utilization of the company was only 42%. He submitted that the assessee had to incur overhead expenses and provide for depreciation irrespective of the level of capacity actually utilized. He submitted that the higher the capacity utilization, per unit cost allocable out of overheads and depreciation would be lower and vice versa. He submitted that the comparable companies have achieved capacity utilization of 70% . He submitted that the profit margin of the company would be badly affected if the capacity of the assessee is under utilised. Accordingly, the Ld A.R submitted that the depreciation and overheads should be excluded in the case of comparable companies, so that the effect of difference in capacity utilisation is ironed out, which will lead to a meaningful comparison.
5. The Ld A.R submitted that adjustment on account of difference in level of capacity utilization is one of the recognized adjustments. In support of the same, the learned 4 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
AR placed his reliance on the decision rendered by the Hon'ble Bombay High Court in the case of CIT v. Petro Araldite (P.) Ltd. [(2018) 93 taxmann.com 438 (Bom.)], wherein it was held that when there is a difference in the level of capacity utilization of the assessee and the level of capacity utilization of comparable, then adjustment would be required to be made to profit margin of comparable on account of difference in capacity utilization in terms of Rule 10B(1)(e)(iii). The learned AR also placed reliance on the decision rendered by the Delhi Bench of the Tribunal in the case of DCIT v. Claas India (P.) Ltd. [(2015) 62 taxmann.com 173 (Delhi-Trib.)], wherein also it was held that adjustment for the difference in capacity utilization is required to be made to iron out the difference. The learned AR submitted that the Delhi Bench of the Tribunal, in the above said case, has also held that the capacity adjustment should be made in the hands of comparable companies and has also explained as to how the capacity utilization adjustment is required to be made. Accordingly, the learned AR prayed that the adjustment towards difference in capacity utilization be allowed.
6. The learned Departmental Representative, on the contrary, supported the order passed by the learned CIT(A).
7. We heard the parties and perused the record. We noticed that the Hon'ble Bombay High Court in the case of Petro Araldite (P.) Ltd. (supra) and the Delhi Bench of the Tribunal in the case of Claas India (P.) Ltd. (supra) have held that the adjustment towards difference in capacity utilization 5 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
is required to be made in terms of Rule 10B(1)(e)(iii) of the Income-tax Rules. In the instant case, it is the submission of the assessee that the average capacity utilization achieved by it during the year under consideration was 42%, while the capacity utilization achieved by comparables during the same period was 70%. The learned AR was specifically asked to provide the data as to how the capacity utilization achieved by the comparables was computed at 70% . The learned AR submitted that he does not possess the details as of now and further submitted that the assessee would be in a position to furnish the said details to the AO / TPO, if the matter is remanded to their files.
8. We noticed that the Delhi Bench of the Tribunal has made a detailed discussion on the adjustment to be made on account of difference in the level of capacity utilization in the case of Claas India (P.) Ltd. (supra). For the sake of convenience, we extract below the relevant discussions made by the Delhi Bench of the Tribunal:-
"6. The second segment of Ground no. 1 of the Revenue's appeal is against the allowing of capacity adjustment in respect of certain items of expenses, which was denied by the TPO.
7. The facts apropos this issue are that the assessee claimed to have worked at a capacity of 29% during the year in question. It was further claimed that the three comparables chosen by it worked at the average capacity utilization of 44%. That is how, the assessee claimed capacity utilization adjustment by reducing its operating costs accordingly. In support of deduction, the 6 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
assessee filed a report of Mr. Chandra Wadhva, a Cost Accountant. As per this report, the capacity utilization of the assessee as well as the comparables was initially raised to 100%. The TPO partly accepted the claim of the assessee. He considered VST Tractors and Tillers and Punjab Tractors Ltd. (Seg.) for the purposes of allowing capacity adjustment with an average capacity utilization taken at 54%. Thereafter, he restricted the reduction in operating costs of the assessee due to capacity utilization, to some Administrative costs and other expenses. As against the assessee's actual deduction of Rs.6,65,79,916 for such selective items of administrative and other expenses, the TPO adjusted such costs to Rs.6,30,30,739 by applying the factor of 29/54 (29%, being, the assessee's capacity utilization and 54%, being, the average capacity utilization of comparables chosen by him). Similarly, he reduced the amount of Depreciation claimed by the assessee at Rs.1,19,60,921 to Rs.64,23,458 by applying the same factor of 29/54. After allowing this capacity utilization adjustment, he determined OP/TC of the assessee at a loss of (-) 7.78%. Total cost of the assessee was taken at Rs.36.88 crore. By applying the arithmetic mean of the profit rate of comparable companies chosen by him at 11.92%, he proposed a transfer pricing adjustment of Rs.7,26,60,103/-, for which addition was made by the AO. The ld. CIT(A) accepted the assessee's contention about not making any TP adjustment in relation to non- AE transactions. The Revenue is not aggrieved to that extent. As regards adjustment for capacity utilization, the ld. CIT(A), by considering the companies finally held by him as comparable, applied the factor of 29/46 for reducing the operating costs actually incurred by the assessee. Apart from the adjustments allowed by the TPO on Administration expenses and Depreciation, the ld. CIT(A) also reduced Advertisement & Marketing expenses, Employee cost (by taking entire employee cost, other than bonus, at Rs.35515709 as fixed). The Revenue is aggrieved 7 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
against the allowing of capacity utilization adjustment to this extent by the ld. CIT(A).
8. We have heard the rival submissions and perused the relevant material on record. Before embarking upon the question of allowability and extent of capacity adjustment under the TNMM, we want to make it clear that the assessee reduced its operating costs by considering its capacity utilization vis-à-vis that of comparables and resultantly claimed that its increased profit as a result of such reduced operating costs be compared with that of the comparables. The TPO has also agreed in principle with the otherwise availability of the capacity adjustment. The issue of allowing capacity adjustment before us can be divided into two sub-issues for consideration, viz., first, whether the adjustment should be allowed in the hands of the assessee as has been done by the authorities below or comparables and second, how to compute capacity utilization adjustment under the TNMM. We will deal with these aspects one by one.
i. Capacity adjustment should be allowed in whose hands ?
9.1. It has been noticed above that the assessee claimed idle capacity adjustment by reducing its own operating costs. It is further observed that the authorities below have reduced the amount of adjustment by excluding certain costs from the ambit of the costs qualifying for adjustment. However, the adjustment has been ultimately allowed from the operating costs incurred by the assessee. In such circumstances, the question arises as to whether the action of the authorities in allowing the reduction of the operating costs incurred by the assessee, is in accordance with law? In order to find answer to this question, we need to refer to the manner of computation of the arm's length price under TNMM, which has been set out in Rule 10B(1)(e) as under:-8 IT(TP)A No.341/Bang/2014.
M/s.SKF Technologies India Pvt. Ltd.
"(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."
9.2. Sub-clause (i) in the process of determination of the ALP under the TNMM talks of the computation of net operating profit margin realized by the assessee from an international transaction. Sub-clause (ii) is the computation of net operating profit margin realized by an unrelated enterprise from a comparable uncontrolled transaction. This refers to determining the operating profit margin of comparables with the same base as 9 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
that of the assessee. Sub-clause (iii) provides that the net profit margin realized by a comparable company, determined as per sub-clause (ii) above, 'is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, ..... which could materially affect the amount of net profit margin in the open market.' It is this adjusted net profit margin of the unrelated transactions or of the comparable companies, as determined under sub-clause (iii), which is used for the purposes of making comparison with the net profit margin realized by the assessee from its international transaction as per sub-clause (i).
9.3. Sub-rule (2) of Rule 10B provides that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to certain factors which have been enumerated therein. Rule 10B(3) states that an uncontrolled transaction shall be comparable to an international transaction, if either there are no differences between the two or a 'reasonably accurate adjustment can be made to eliminate the material effects of such differences.' When we read sub- clauses (ii) & (iii) of Rule 10B(1)(e) in juxtaposition to sub-rules (2) & (3) of rule 10B, the position which emerges is that the net operating profit margin of comparable companies calls for adjustment in such a manner so as to bring both the international transaction and comparable cases at the same pedestal. In other words, if there are no differences in these two, then the average of the net operating profit margin of the comparable companies becomes a benchmark. However, in case there are some differences between the comparables and the assessee, then the effect of such differences should be ironed out by making suitable adjustment to the operating profit margin of comparables. That is the way for bringing both the transactions, namely, the international transaction and the comparable uncontrolled transactions, on the same platform for 10 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
making a meaningful and effective comparison. The above analysis overtly transpires that the law provides for adjusting the profit margin of comparables on account of the material differences between the international transaction of the assessee and comparable uncontrolled transactions. It is not the other way around to adjust the profit margin of the assessee. In other words, the net operating profit margin realized by the assessee from its international transaction is to be computed as such, without adjusting it on account of differences with the comparable uncontrolled transactions. The adjustment, if any, is required to be made only in the profit margins of the comparables. 9.4. Reverting to the facts of the instant case, we find that the authorities below have adjusted the operating costs of the assessee in allowing the capacity adjustment. As against that, the correct course of action provided under the law is to adjust the operating costs of the comparable and their resultant operating profit. There is hardly need to accentuate that there can be no estoppel against the law. Once the law enjoins for doing a particular thing in a particular manner alone, it is not open to anyone to adopt a contrary or different approach. As the authorities below have adopted a course of action in allowing adjustment, which is not in consonance with law, we cannot approve the same. The impugned order is set aside and the matter is restored to the file of the TPO/AO for giving effect to the amount of idle capacity adjustment in the operating profit of the comparables and not the assessee.
ii. How to compute capacity utilization adjustment under TNMM : -
10.1. Under the TNMM, the ALP of an international transaction is determined by computing and comparing the percentage of operating profit margin realized by the assessee with that of the comparables. We have noticed 11 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
above that the difference in the capacity utilizations is an important factor, which needs to be adjusted. No mechanism has been given under the Act or the rules for computing the amount of capacity utilization adjustment. 10.2. On an overall understanding, we feel that under the TNMM, the first step in granting capacity utilization adjustment is to ascertain the percentage of capacity utilization by the assessee and comparables. There can be no difficulty in working out these percentages. The second step is to give effect (positive or negative) to the difference in the percentage of capacity utilizations of the assessee vis-à-vis comparables, one by one, in the operating profit of comparables by adjusting their respective operating costs. Operating costs can be either fixed or variable or semi-variable. One needs to split semi-variable costs into the fixed part and variable part. In so far as the variable costs and the variable part of the semi-variable costs are concerned, these remain unaffected due to any under or over utilization of capacity. Accordingly, such variable operating costs remain unchanged. The adjustment is called for only in respect of the fixed operating costs and fixed part of semi-variable costs. Such costs are scaled up or down by considering the percentage of capacity utilization by the assessee and such comparable. It can be illustrated with the help of a simple example. Suppose the fixed costs incurred by a comparable (say, A) are Rs. 100 and it has capacity utilization of 50% as against the capacity utilization of 25% by the assessee. The above percentages show that the assessee has incurred full fixed costs with 25% of the utilization of its capacity, as against A incurring full fixed costs with 50% of its capacity utilization. This divulges that the assessee has incurred relatively more fixed costs and A has incurred lower costs. In order to make an effective comparison, there arises a need to obliterate the effect of this difference in capacity utilizations. It can be done by proportionately scaling up the fixed costs incurred by A 12 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
so as to make it fully comparable with the assessee. This we can do by increasing the fixed costs of A to Rs. 200 (Rs.100 into 50/25) as against the actually incurred fixed costs by it at Rs.100. When we compute operating profit of A by substituting the fixed costs at Rs.200 with the actually incurred at Rs.100, it would mean that the fixed costs incurred by the assessee and A are at the same capacity utilization. There can be converse situation as well. Suppose the fixed costs incurred by a comparable (say, B) are Rs. 100 and it has capacity utilization of 25% as against the capacity utilization of 50% by the assessee. The above percentages show that the assessee has incurred full fixed costs at 50% of the utilization of its capacity, as against B incurring full fixed costs at 25% of the capacity utilization. This deciphers that the assessee has incurred relatively lower fixed costs and B has incurred higher costs. This difference in capacity utilizations can be eliminated by proportionately scaling down the fixed costs incurred by B so as to make it fully comparable. This we can do by reducing the fixed costs of B to Rs. 50 (Rs.100 into 25/50) as against the actually incurred fixed cost by it at Rs.100. When we compute operating profit of B by substituting the fixed costs at Rs.50 with the actually incurred at Rs.100, it would mean that the fixed costs incurred by the assessee and B are at the same capacity utilization level."
8. In view of the decision rendered by the Hon'ble Bombay High Court and the Delhi bench of Tribunal, we find merit in the prayer of the assessee for the adjustment towards the difference in the level of capacity utilization. Since this issue has not been examined by the tax authorities and since the assessee has to furnish necessary details in order to support its claim, which in turn requires examination at the end of AO, we deem it proper to restore it to the file of the AO / TPO 13 IT(TP)A No.341/Bang/2014. M/s.SKF Technologies India Pvt. Ltd.
for examining the claim of the assessee. Accordingly, we set aside the order passed by the learned CIT(A) on this issue and restore the same to the file of the AO / TPO for examining the claim of the assessee, in accordance with law, by duly considering the decisions rendered by the High Court / Tribunal on capacity utilization adjustment. After affording adequate opportunity of being heard to the assessee, the A.O. may take appropriate decision in accordance with law.
9. In the result, the appeal filed by the assessee is treated as allowed for statistical purposes.
Order pronounced on this 15th day of February, 2019.
Sd/- Sd/-
(N.V.Vasudevan) (B.R.Baskaran)
VICE-PRESIDENT ACCOUNTANT MEMBER
Bangalore ; Dated : 15th February, 2019.
Devdas*
Copy of the Order forwarded to :
1. The Appellant
2. The Respondent.
3. The CIT(A)-IV, Bangalore
4. The CIT-III Bangalore.
5. The DR, ITAT, Bangalore
6. Guard file.
True copy
BY ORDER,
(Asstt. Registrar)
ITAT, Bangalore