Income Tax Appellate Tribunal - Delhi
M/S. Daikin Airconditioning India Pvt. ... vs Dcit, New Delhi on 19 March, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I-1 : NEW DELHI
BEFORE SHRI R.S. SYAL, VICE PRESIDENT
AND
SHRI KULDIP SINGH, JUDICIAL MEMBER
ITA Nos.2536/Del/2014 &1207/Del/2015
Assessment Years : 2009-10 & 2010-11
Daikin Airconditioning India Pvt. Ltd., Vs. DCIT,
th
12 Floor, Building No.9, Tower-A, Circle-7(1),
DLF Cyber City, DLF Phase III, New Delhi.
Gurgaon.
PAN: AABCD0971F
ITA No.2547/Del/2014
Assessment Year : 2009-10
DCIT, Vs. Daikin Airconditioning
Circle-7(1), India Pvt. Ltd.,
New Delhi. 12th Floor, Building
No.9, Tower-A,
DLF Cyber City, DLF
Phase III,
Gurgaon.
PAN: AABCD0971F
(Appellant) (Respondent)
Assessee By : Shri Vishal Kalra &
Ms Khyati Dadhwal, Advocates
Department By : Shri Sanjay I Bara, CIT, DR
ITA Nos.2536 & 2547/D/2014 &
ITA No.1207/Del/2015
Date of Hearing : 15.03.2018
Date of Pronouncement : .03.2018
ORDER
PER R.S. SYAL, VP:
This batch of three appeals comprises of two cross appeals for the assessment year 2009-10 and one appeal by the assessee for the assessment year 2010-11. Since some of the issues raised in these appeals are common, we are, therefore, proceeding to dispose them off by this consolidated order for the sake of convenience.
Assessment Year 2009-10
2. These cross appeals arise out of the final assessment order passed by the Assessing Officer (AO) on 28.02.2014 u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called 'the Act').
3. The only issue raised by the Revenue in its appeal is against the direction of the Dispute Resolution Panel (DRP) requiring the Assessing Officer to consider domestic brand owners as comparable for the purpose of computing bright line limit in the context of addition on account of transfer pricing adjustment in Advertisement, marketing and promotion 2 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 (AMP) expenses. Ground No.2 of the assessee's appeal is against addition of Rs.5,58,24,315/- made by the AO on account of transfer pricing adjustment in the international transaction of AMP expenses.
4. Succinctly, the factual matrix of the case is that the assessee is engaged in the business of import and sale of all types of refrigeration equipments and accessories. During the year, the assessee was also in the process of setting up its manufacturing plant for manufacture and sale of such goods in India. The assessee is a subsidiary of Daikin Japan, which holds 99.9999% of its share capital, leaving the remaining 0.0001% for Daikin Indus Management Service Asia (Pte) Ltd., Singapore. The assessee reported six international transactions in Form No.3CEB. The AO made reference to the Transfer Pricing Officer (TPO) for determining the arm's length price (ALP) of the international transactions. The TPO, on the basis of the elaborate discussion made by him in his order dated 29.01.2013, proposed transfer pricing adjustment on account of AMP expenses at Rs.18,19,73,249/-. The assessee approached the Dispute Resolution Panel (DRP). After giving effect to the directions given by the DRP, the TPO and thereafter, the Assessing Officer, made transfer pricing 3 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 addition of Rs.5,58,24,315/- on AMP expenses. The assessee is aggrieved against the addition.
5. We have heard both the sides and perused the relevant material on record. It is observed that similar issue came up for consideration before the Tribunal in the assessee's own case for the immediately preceding three assessment years, namely, 2006-07 to 2008-09. Vide order dated 17.04.2017, the Tribunal, on the assessee's request, remitted the matter to the file of Assessing Officer/TPO for taking a fresh decision on the existence or otherwise of the international transaction of AMP expenses and, then, determining the ALP of such international transaction of AMP expenses, if it is found to exist. The Tribunal further directed that selling expenses should not be considered within the ambit of AMP expenses. The ld. AR fairly conceded that the issue of AMP expenses for the instant year may also be restored to the file of Assessing Officer/TPO for taking a fresh decision in line with the directions given by the Tribunal for the preceding three years. The ld. DR did not raise any objection to it. Respectfully following the precedent, we set aside the impugned order on this score and remit the matter to the file of Assessing Officer/TPO for deciding this issue 4 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 afresh as per law, after allowing a reasonable opportunity of being heard to the assessee. The TPO, in doing this exercise afresh, will take into consideration the directions given by the Tribunal in its aforenoted order.
6. The next issue raised through Ground No.3 of the assessee's appeal is against the addition on account of transfer pricing adjustment amounting to Rs.8,44,864/- on account of `Payment of consultancy expenses' in relation to its Distribution operations. Ground No.5, which is connected with Ground No.3, is against treating `Consultancy expenses' of Rs.4,96,20,173/- as capital in nature relating to setting up of its Manufacturing unit.
7. The facts apropos these issues are that the assessee reported an international transaction of 'Receipt of consultancy services (sic fee) and training services' with transacted value of Rs.7,94,14,638/-. The assessee aggregated the international transaction of `Payment of consultancy charges' with its international transactions under the `Manufacturing segment' and benchmarked the same using the Transactional Net Margin Method (TNMM) as the most appropriate method on entity level. The TPO 5 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 did not accept the aggregation of the transaction of `Payment of consultancy fee' with the international transactions of the `Manufacturing segment' and applying the TNMM on entity level. He opined that payment of `Consultancy charges' amounting to Rs.7.94 crore should be benchmarked separately under the Comparable Uncontrolled Price (CUP) Method. By applying the CUP method, he determined the ALP of this international transaction at Nil and, accordingly, proposed transfer pricing adjustment of Rs.7.94 crore. The assessee assailed this issue before the DRP, which considered the nature of services provided by the consultants, as reproduced on pages 40 to 44 of its directions. It was found that most of the payments made to expatriate consultants were in connection with setting up of manufacturing unit of the assessee, in progress during the year under consideration. Such a finding was rendered on perusal of the assessee's Profit & Loss Account which depicted no revenue from sale of manufactured goods. It was, therefore, held that such payments were required to be capitalized. The matter was sent back to the TPO with a direction to the assessee to furnish details of expat personnel visiting India for facilitation of setting up of the manufacturing unit. The TPO was 6 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 directed to treat such amount as capital expenditure. Giving effect to the directions of the DRP, the TPO proposed a fresh transfer pricing adjustment on account of consultancy charges at Rs.8,44,864/- treating Nil ALP in relation to the distribution segment. The Assessing Officer treated a sum of Rs.4,96,20,173/- as capital expenditure relating to the setting up of manufacturing unit. This is how, the assessee is aggrieved on two counts on this issue.
8. We have heard the rival submissions and perused the relevant material on record. It is seen that the assessee reported an international transaction of 'Receipt of consultancy and training services' amounting to Rs.7.94 crore. The ld. AR explained that the DRP deleted the addition of Rs.25 lac towards payment made for `Training services', leaving the remaining amount at Rs.7.86 crore. He further submitted that a sum of Rs.2.64 crore out of such total amount was suo motu capitalized by the assessee and the Assessing Officer has made a further capitalization of consultancy fee amounting to Rs.4.96 crore by treating the remaining amount of Rs.8,44,864/- as a revenue transaction relatable to distribution segment but treated its ALP at Nil. The ld. AR argued that the Assessing 7 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 Officer was not justified in capitalizing a further sum of Rs.4.96 crore towards payment of consultancy fee in addition to Rs.2.64 crore already capitalized by the assessee.
9. It is undisputed that setting up of the manufacturing unit of the assessee was in progress during the year under consideration. As such, all expenses in relation to such setting up of unit were required to be capitalized as has been admitted by the assessee as well, which is evident from the voluntary capitalization of certain amount of consultancy expenses, claimed to be the only consultancy expenses in relation to setting up of the manufacturing unit. Thus, there can be no question of claiming deduction of any consultancy expenses in connection with the setting up of manufacturing unit. We have gone through the order of the DRP in which details of consultancy services rendered by foreign experts have been given on pages 40 to 44 of its direction. First is payment of Rs.41.15 lac to Hiroyuki Nakabayashi. Under the column 'Nature of work undertaken', it has been mentioned as 'Preparation of all legal licenses, approvals, registrations for factory set up' etc. Under the benefit column against this payment, it has been mentioned: 'Assistance in setting up of manufacturing 8 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 facility in India', 'Seeking all necessary approvals'. Then, there is payment of Rs.43,74,421/- to Yuichi Tateoka. Under the column 'Nature of work undertaken', it has been mentioned as 'Equipment local content Result check.'. Next is payment of Rs.37,75,485/- to Kazuya Orita and the nature of work has been given as : 'Discuss about specification of equipment.' A sum of Rs.59,30,109/- has been shown to have been paid to Toshio Masuda and the nature of work has been mentioned as 'Meeting with accounting section; Factory CS and Budget' and `Production equipment order.' In this way, details have been given in respect of 12 payments which apparently show that most of the services provided by the expats are in connection with the setting up of the factory. At the same time, it is also vivid that some services have been rendered by the expats qua the running business of Distribution, which are of the revenue nature. It goes without saying that an expenditure incurred in relation to setting up manufacturing unit cannot be considered as of revenue nature and the same has to be capitalized. Since complete details of such amount are not available, we are of the considered opinion that the ends of justice would meet adequately if the impugned order on this issue is set aside and the matter is restored to the file of 9 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 Assessing Officer/TPO. We order accordingly and direct him to examine each and every item of payment of consultancy fee and, then, capitalize such amounts as relate to the setting up of manufacturing unit. Since the DRP has simply directed the TPO/A.O. to capitalize the expenditure relating to manufacturing unit and the ALP of the same has neither been directed to be nor actually determined by the TPO/A.O., we cannot enlarge the controversy by directing the authorities to determine the ALP of the amount to be capitalized.
10. Now, we espouse the remaining sum of Rs.8,44,864/-, whose ALP has been determined by the authorities at Nil. We have noticed above that the assessee benchmarked the international transaction of `Payment of consultancy fee' by aggregating it with the `Manufacturing segment' and, then, determined the ALP on aggregate basis under the TNMM. The TPO has benchmarked this part of the transaction under the CUP method.
11. It is, no doubt, true that two or more international transactions can be aggregated. However, it is sine qua non that the two or more transactions, in order to be aggregated, must be interlinked and have a close connection 10 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 with each other. Two separate and independent transactions cannot be bundled together for the purposes of benchmarking, in the absence of their having any close connection or live link with each other. The Delhi Bench of the Tribunal in Gruner India Pvt Ltd [TS-202-ITAT-2016(DEL)-TP] has held that Royalty and Fees for technical services are not closely-linked and hence approved the TPO's segregation.
12. Adverting to the facts of the instant case, we find that the assessee has bundled the international transaction of `Payment of consultancy fee' with its `Manufacturing segment'. Primarily, it is seen that the assessee did not undertake any manufacturing activity as the manufacturing unit was being set up during the year. In such a case, there could have been no reason to aggregate the transaction of `Payment of Consultancy fee' with the `Manufacturing segment'. Secondly, both the transactions do not have any close connection and are independent of each other and, hence, cannot be aggregated for the purpose of benchmarking. Once the international transaction of `Payment of consultancy fee' is segregated from the international transactions of `Manufacturing segment', the former transaction under consideration needs to be separately benchmarked. 11
ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 Considering the nature of the international transaction of receipt of consultancy services, the same, in our considered opinion, needs to be more appropriately benchmarked on a comparison with another similar transaction of service under the CUP method rather than on profit level under the TNMM. We, therefore, approve the application of the CUP as the most appropriate method for determining the ALP of the remaining amount of consultancy expenses paid after excluding the amount to be capitalized as relating to the setting up of manufacturing unit in terms of our foregoing discussion.
13. In this regard, it is observed that the TPO computed Nil ALP on the ground that the assessee did not show any service having been actually received by it and, further, no independent party would have made a similar payment in uncontrolled similar circumstances. While applying the CUP method, it was obligatory upon him to bring on record some comparable uncontrolled instance(s) as per the mandate of rule 10B(1)(a)(i). Not even a single comparable instance has been brought on record to facilitate a comparison between the price for the service vis-à-vis that paid by other comparables in similar uncontrolled circumstances. In the same breath, the 12 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 assessee has also not placed on record any comparable uncontrolled transaction which could enable the determination of ALP of the transaction.
14. Be that as it may, it is noticed that the action of the TPO in determining Nil ALP of the international transaction on the ground that no benefit accrued to the assessee and then the AO making addition simply on the basis of recommendation of the TPO, is not in accordance with the judgment of the Hon'ble Delhi High Court in CIT v. Cushman & Wakefield (India) (P.) Ltd. (2014) 367 ITR 730 (Del), in which it has been held that the authority of the TPO is limited to conducting transfer pricing analysis for determining the ALP of an international transaction and not to decide if such service exists or benefits did accrue to the assessee. Such later aspects have been held to be falling in the exclusive domain of the AO. In that case, it was observed that the e-mails considered by tribunal from Mr. Braganza and Mr. Choudhary dealt with specific interaction and related to benefits obtained by assessee, providing a sufficient basis to hold that benefit accrued to assessee. As the details of specific activities for which cost was incurred by both AEs (for activities of Mr. Braganza and Mr. Choudhary), and attendant benefits to assessee were not considered, the 13 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 Hon'ble High Court remanded the matter to file of concerned AO for an ALP assessment by TPO, followed by AO's assessment order in accordance with law considering the deductibility or otherwise as per section 37(1) of the Act.
15. When we come back to the facts of the extant case, it turns out that the TPO proposed the transfer pricing adjustment, inter alia, by holding that no benefit was received by the assessee and hence no payment on this score was warranted. The TPO further noted on page 44 of his order that :
`the assessee has not submitted the details regarding the services availed and the consequent benefits received despite the fact that in the show cause letter, it was told specifically to identity each of the services actually received from the AEs for which the amount has been paid. Instead it has given general description for the so-called services and their benefits without linking these two aspects." It has also been reiterated on the same page that the assessee did not file any specific/concrete details regarding receipt of services in lieu of payment of consultancy fee to its AE. In the concluding para 17 of his order, the TPO has recorded that : `the assessee has not been able to show that any services have actually received by it.' 14 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 He further held that : `no independent party would have made a similar payment in uncontrolled circumstances'. The AO in his draft order has taken the ALP of the international transaction at Nil on the basis of such recommendations of the TPO without carrying out any independent investigation for the deductibility or otherwise of such a payment in terms of section 37(1) of the Act. This addition has been made by the AO in his final assessment order giving effect to the direction given by the DRP and not by invoking section 37(1) of the Act. As per the ratio decidendi of Cushman & Wakefield India (P.) Ltd. (supra), the TPO was required to simply determine the ALP of the international transaction, unconcerned with the fact, if any benefit accrued to the assessee and thereafter, it was for the AO to decide the deductibility of this amount u/s 37(1) of the Act. As the TPO in the instant case determined Nil ALP by holding that no benefit accrued to the assessee etc. and the AO made the addition without examining the applicability of section 37(1) of the Act, we find the actions of the AO/TPO running in contradiction with the ratio laid down in Cushman & Wakefield (supra). In these circumstances, we set aside the impugned order on this score and send the matter to the file of AO/TPO for 15 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 deciding it in conformity with the above discussion and the law laid down by the Hon'ble Delhi High Court in the aforenoted case. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such proceedings. These two grounds are, therefore, allowed for statistical purposes.
16. Other grounds of the appeal are either consequential or general, not requiring any specific adjudication.
Assessment Year 2010-11
17. This appeal filed by the assessee arises out of the final assessment order passed by the Assessing Officer on 29.12.2014 u/s 143(3) read with section 144C of the Act.
18. The first issue raised in this appeal is against addition on account of transfer pricing adjustment of Rs.12,06,57,010/- on account of AMP expenses. The ld. AR did not raise any objection to the restoration of this issue to the TPO/A.O. for fresh adjudication in accordance with the orders passed by the Tribunal for earlier years. Following the view taken hereinabove, we set aside the impugned order on account of AMP expenses 16 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 and remit the matter to the file of A.O./TPO for deciding it afresh in consonance with our directions given hereinabove.
19. Next issue raised in this appeal is against the addition of Rs.9,77,68,737/- on account of `Payment of consultancy and training expenses' treating the same as not at ALP. The assessee reported an international transaction of 'Receipt of training and consultancy services' with transacted value of Rs.9,77,68,737/-. The TPO determined Nil ALP of this international transaction, which resulted into the recommendation of transfer pricing adjustment of Rs.9.77 crore. The DRP echoed the action of the TPO in determining Nil ALP. This led to an addition of Rs.9.77 crore on this transaction, against which the assessee has come up in appeal before the Tribunal.
20. We have heard both the sides and perused the relevant material on record. The TPO has noticed on page 65 of his order: 'that the assessee has not been able to prove that he has actually received services of some value that can call for cost allocation.' Then, again, he recorded on page 66 of his order that: 'the taxpayer has not been able to show as to when and how the 17 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 various services were requisitioned from the AEs, whether the services were actually needed by it, whether the same were actually received by it by producing contemporaneous documentary evidence at the time of entering into agreement or at the time of availing the service (if actually availed).' He summed up his analysis in para 5.13 of his order as under:-
"5.13 As can be seen from the reply of the assessee as stated above he was unable to give a clear reply along with documentary evidence on any of the following issues:
1. Contemporaneous documentary evidence to show that these services have actually been received.
2. Need for the receipt of such services for which payment has been made
3. Documentary evidence as to when and how these services were requisitioned from the AEs.
4. Basis of determination of rate of payment for IGS at the time of entering into the agreement.
5. Details of cost benefit analysis vis a vis the expected benefit from the IGS and the payment made for the same.
6. Details of benchmarking analysis done at the time of entering into the agreement so as to compare the payment of IGS to the AE vis a vis an independent party under similar circumstances.
7. Tangible and direct benefits derived by the assessee company from the use of such IGS.
8. Details and documentary evidence of cost incurred by the AE for rendering each type of services purportedly received by the assessee company."
21. Thereafter, it was noticed that: 'the assessee has not been able to demonstrate, based on any contemporaneous documentary evidence that it received any services performed by the expatriates.' As against the above 18 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 findings recorded by the TPO, the assessee contended that the services were, in fact, availed from expatriates.
22. It is observed that unlike the preceding year, the DRP did not direct the TPO to examine the expenses in connection with setting up of the manufacturing unit and, then, capitalize the same. Certain details indicate some expenditure of the capital nature booked under this head. Since the assessee claimed the entire amount as a revenue expenditure and the authorities did not hold any part of the same as relating to setting up of the manufacturing unit and hence capital, we cannot direct a part of such expenditure to be capitalized.
23. In this year, again, the assessee aggregated the international transaction of `Payment of consultancy fee and training services' with the `Manufacturing segment' and indicated the same at ALP by following the TNMM on entity level. The TPO, like preceding year, followed the CUP method without indicating any comparable uncontrolled transaction and computed Nil ALP and the assessee has also not placed on record any comparable uncontrolled transaction. It is thus seen that the material facts 19 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 and circumstances of this ground, in so far as they concern with treating Nil ALP of the non-capital Consultancy services expenditure, are essentially similar to those of the preceding year. We have dealt with this issue in earlier paras. We have discussed above the judgment of the Hon'ble Delhi High Court in CIT v. Cushman & Wakefield (India) (P.) Ltd. and noticed how the orders of the A.O./TPO are not in consonance with the ratio laid down in the said decision and eventually sent the matter back for a fresh determination. Following the view taken hereinabove, we hold that payment of consultancy fee is a separate international transaction, which is required to be benchmarked separately under the CUP method. The AO/TPO is directed to follow the mandate given by us hereinabove while disposing of similar ground for the immediately preceding year and determine afresh the ALP of the international transaction of `Payment of consultancy and training charges'. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such proceedings.
20
ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015
24. The only other effective issue which survives in this appeal is against not allowing `Capacity adjustment' in the `Manufacturing segment'. The assessee claimed `idle capacity adjustment' in the `Manufacturing segment' before the TPO vide its submission dated 10.01.2014. The Officer observed that in some of the comparables, production was done on a single shift basis while in others, the figures were given on double/triple shift basis. It was still further observed that the assessee took up figures of `Licensed capacity' instead of `Installed capacity' for computing the percentage of capacity utilization by the six comparables under this segment. In the absence of the availability of any reliable data and lack of uniformity in its application on all the comparables, the TPO refused to grant any capacity utilization adjustment. The DRP did not interfere in the draft order on this score. That is how, the assessee's claim for grant of capacity utilization adjustment was turned down, against which the assessee has come up in appeal before the Tribunal.
21
ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015
25. After considering the rival submissions and perusing the material on record, we find that the assessee employed the TNMM for benchmarking the international transaction of manufacturing segment. Modus operandi for calculation of the ALP under the TNMM has been prescribed in Rule 10B(1)(c) 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."
22
ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015
26. 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 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).
27. Sub-rule (2) of Rule 10B provides that the comparability of an international transaction with an uncontrolled transaction shall be judged 23 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 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 out for bringing both the transactions, namely, the international transaction and the comparable uncontrolled transactions, on the same platform for making a meaningful and effective comparison.
24
ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015
28. 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 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.
29. 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 vis-à-vis the installed capacity 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 25 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 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 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 26 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 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.
27
ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015
30. The ld. AR has brought to our notice that the ld. CIT(A) for the assessment year 2012-13 has also directed the authorities below to grant capacity utilization adjustment. A copy of such order dated 31.10.2017 has been placed on record. The assessee submitted that no appeal has been filed against this order and the same has attained finality. This contention was not controverted by the ld. DR with any cogent material.
31. Turning to the facts of the instant case, we find that complete financials of all the comparable companies are not available on record. Thus, it is not possible at our end to work out the amount of capacity adjustment in the manner discussed above. Ergo, we set aside the impugned order and direct the TPO/AO to work out the amount of capacity utilization adjustment afresh in terms of our above observations. It is made clear that the capacity adjustment will be considered in the hands of the comparables by taking into account `Installed capacity' vis-à-vis the actual production and not the `Licensed capacity' vis-à-vis the actual production. Further, the production on double shift or triple shift basis in case of certain comparables also needs to be suitably adjusted. Needless to say, the 28 ITA Nos.2536 & 2547/D/2014 & ITA No.1207/Del/2015 assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings.
32. Other grounds are either consequential or general not requiring any specific adjudication.
33. In the result, both the appeals are allowed for statistical purposes.
The order pronounced in the open court on 19.03.2018.
Sd/- Sd/-
[KULDIP SINGH] [R.S. SYAL]
JUDICIAL MEMBER VICE PRESIDENT
Dated, 19th March, 2018.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.
29