Income Tax Appellate Tribunal - Kolkata
Dcit, Cir. 1(1), Kolkata vs M/S Kyocera Ctc Precision Tools Pvt. ... on 2 June, 2023
IN THE INCOME TAX APPELLATE TRIBUNAL "C" BENCH KOLKATA
BEFORE SHRI RAJPAL YADAV, VICE PRESIDENT
AND SHRI GIRISH AGRAWAL, ACCOUNTANT MEMBER
ITA No.233/Kol/2022
Assessment Year: 2015-16
Deputy Commissioner of Kyocera CTC Precision Tools
Income-tax, Circle- 1(1), Pvt. Ltd.,
Kolkata Vs. Room No. 322, Centre Point,
21, Hemant Basu Sarani,
Kolkata-700001.
(PAN: AAECK9063G)
(Appellant) (Respondent)
Present for:
Appellant by : Shri Rahul Saha, CA
Respondent by : Shri G. Hukugha Sema, CIT, DR
Date of Hearing : 22.05.2023
Date of Pronouncement : 02.06.2023
ORDER
PER GIRISH AGRAWAL, ACCOUNTANT MEMBER:
This captioned appeal filed by the Revenue is against the order of Ld. CIT(A),Kolkata-22 vide order No. ITBA/APL/S/250/2021-22/1038315872(1) dated 31.12.2021 against the assessment order of Ld. ACIT, Circle-1(1), Kolkata u/s. 144C/143(3) of the Income-tax Act, 1961 (hereinafter referred to as the "Act"), dated 21.10.2019 for AY 2015-16.
2. At the outset, we note that there is a delay of 24 days in filing the present appeal. Department has placed on record a petition for condonation of delay, dated 06.05.2012. The impugned order of Ld. CIT(A) is dated 31.12.2021 which falls during the period of Pandemic of Covid-2019. This period has been excluded by the Hon'ble Supreme Court in the case of suo moto Writ Petition (C) No. 3 of 2020 dated 10.01.2022 by which the period from 15.03.2020 to 28.02.2022 has 2 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 been directed to be excluded for the purpose of limitation. Vide this order a further period of 90 days has been granted for providing the limitation from 01.03.2022. Accordingly, we condone the delay and proceed to admit the appeal for hearing.
3. Grounds raised by the revenue are reproduced as under:
"1. Th at o n the f ac ts and cir cu mstances of the Case, the Ld. CIT( A) has erred In dele ting the Transf er Pr ic ing ad ju s tmen t of Rs.1,69,80,694 ma de on accoun t of Internation al AE tr ans ac tion (purchase and s ale ) of the assessee.
2. T hat on the f ac ts and c ircu ms tance s of the Case, the Ld. C IT( A) has erred in relyin g upon the approach adopted b y the assessee f or capac ity u til izatio n ad jus ted PLI wi th out the ap propr iate ver if ic ation of all th e relev an t f ac tu al data f or the compar able co mp anies v is - a-v is the assessee.
3. T hat on the f ac ts and c ircu ms tance s of the Case, the Ld. C IT( A) has erred in no t apprec ia ting that the f indings of the TPO is based on the unav ail abil ity of relevan t f inan cial d ata f or comp ar ab le co mp anies f or allo wing the appro pr iate c apacity util iz a tion adjus tment.
4. T hat on the f ac ts and c ircu ms tance s of the Case, the Ld. C IT( A) has erred in no t apprec iating th at, the Inco me T ax Ac t does no t prov ide any s tandardized me thod to work ou t the cap ac ity util ization adjus ted PLI and, hence, th e adjus ted P LI arr ived by the assessee needs s trong documentar y ev idence on accoun t of assessee as we ll as f or compar able c ompan ie s to subs ta ntiate its benchmarking, wh ich is not avail able in the case of the assessee.
5. That the appe llan t cr aves le ave to add to and /or alte r, amend, mod if y or rescind the grounds hereinabove bef ore or at the time of hear ing of this app eal."
3.1. All of the above grounds of appeal relate to allowing appropriate capacity utilisation adjustment while arriving at the Arms Length Price (ALP) of International Transactions of purchase and sale with Associate Enterprises (AE) of the assessee.
4. Brief facts of the case as culled out from records are that assessee is a joint venture between Kyocera Asia Pacific Pte. Ltd., Singapore (KAPPL) and CTC India Pvt. Ltd. (CTC).
3 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 Asse ssee is engage d in the business of manufacturing cutting tools such as inserts and holders to cater to the automotive industry and other industrial plants. Assessee entity was set up in June, 2012 which commenced its commercial operation in December, 2013. Accordingly, AY 2014-15 was the first year of its commercial operation containing broken period of the year. The impugned AY 2015-16 is the first year whe n operations took place for the full year.
4.1. Assessee has procured raw materials from both AE and non-AEs and processed them into finished products, part of which was supplie d to its AEs. For the international transactions undertake n by the assessee with its AEs in respect of purchase and sale, assessee bench-marked the same by selecting Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for which it carried out a transfer pricing study and furnished a Transfer Pricing Study Report (TPSR) placed on record. Based on the comparable analysis with the Indian Companies, assessee be nchmarked its transactions. From its transfer pricing be nchmarking exercise, the Net Profit Margin (NPM) with the comparable independent companies ranged from 3.20% to 6.14% and median of 4.91%, with Net Cost plus (NCP) the range was 3.30% to 6.54% with median of 5.16%. Assessee took NCP margins as its Profit Level Indicator (PLI) and by applying an adjustment towards its capacity utilisation, arrived at NCP margin of 11.66%. The final list of comparables taken by the assessee and those chosen by the Ld. TPO which have been considered for the purpose of 4 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 be nch marking are not in dispute in this appeal. Details in this respect are tabulated below:-
5 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 4.2 In re spect of capacity utilisation of the assessee in the year under consideration, it is stated that it is at 34% as compared to 73% of the industry (manufacturing and automotive). To arrive at the industry average for capacity utilisation, asse ssee relied on industrial reports sourced from publication by Reserve Bank of India (RBI) and Federation of Indian Chamber of Comme rce & Industry (FICCI) details of which are tabulated as under:
4.3. In the course of proceedings before the Ld. TPO, capacity utilisation adjustment made by the assessee while 6 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 be nchmarking its international transactions was disre garded and adjustments were made by the Ld. TPO which is tabulate d as under:
5. Aggrieved, assesse e went in appeal before the Ld. CIT(A), who considered various aspects on the approach and factored in the adjustment for capacity utilisation. While de aling with the subject of adjustment for capacity utilisation, Ld. CIT(A) has primarily dealt with three aspects which have been e xhaustively and elaborately e xplained in the impugned order. The three broad aspects are given as under :-
(i) Commercial aspect of e ffect of under-utilisation of capacity upon the margins of the concern,
(ii) whether adjustment based on the fact of capacity under-utilisation have any justification, roots or sanction in the various judicial precedents or not.
(iii) whether there is an express embargo upon the making of capacity utilisation adjustment with Rule 7 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 10B(1)(e)(iii) or in any other Rules of the Income-tax Rules, 1962 while working out the profitability parameters of an enterprise.
5.1. The obse rvations made by Ld. CIT(A) on the above three broad aspects of the issue under challenge before us, are extracted as under:
5.1.1.Commercial aspect of effect of underutilisation of capacity upon the margin of the concern, "By def in ition, capac ity u til isation is th e ex tent to wh ich an enter pr ise ac tu ally uses its ins talled produc tive cap ac ity . It is the re la tionship between actual output us ing the ins ta lled inf ras tructure, and the po ten tial outp u t wh ich cou ld ar is e, if c ap ac ity was f ully used. Typically expressed as a pe rcentage, th is f ac tor beco mes an impor tan t co mpar ab il ity f actor as it helps me asure produc tive eff ic iency and cos t ef f icienc y. The costs incurred by any en tity are of two ty pes : var iable cos ts wh ic h v ary d irec tl y with the production level; and f ixed costs whic h rema in roughly at the s ame level irrespec tive of the produc tion level. S ince the var iab le cos t v ar ies dire ctl y with the produc tion level, its recovery re mains un if orm irr espec tive of capacit y u til is a tion, whereas the f ixed cos t wh ich re mains the same is under recovered as a re sul t of under-util is ation of capac ity - resu lting in lo we r prof itabil ity.
This br ings us to the reasons why it is impor tan t to take in to accou nt capac ity u til isa tions in e valua ting the margins or prof itabil ity of an enter pr ise - th is, of course, is with out ref erence at the mo men t to Inco me T ax co ns ider ations. It is co mmon kno wledg e and the phenomenon of lo w capac ity u til is ation is co mmon ly no ticed across manuf ac tu r ing co mpanies dur ing th eir s tar t- up ph ase. While the v ar iable cos ts are incurre d and recovered in tan de m with the quan tity produced, it is the f ixed costs th at are incurre d at the beg inn ing and continue to be incu rred irres pec tive of the actual leve l of production. In su ch c ases, co mpan ies generally incur losses or make n il or negligible prof its owin g to the ir huge investmen ts in f ixed cos ts, whic h canno t be f ully recovered until the c apac ity is f ully u til ised. In the light of such under-util isa tio n of ins talle d c ap acity, it be co mes clear th a t the marg ins earned by the assessee are no t in the reg ular c ourse of business and no t co mp ar able, as 8 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 such, with similar co mpan ies in the indus tr ies unless adjus ted f or. An added f eature th at po in ts to wards the f act tha t if a me an ingf ul evaluation of th e perf o rmance o f a co mpany h as to be under taken in ter ms of mar gins, prof itabil ity e tc, then we f ind that withou t prov id ing f or the adjus tmen t of under-util ised c apac ity , a co mpany would appe ar to have understa ted its opera ting margins ( in the c ase of the appellan t th is h as led to the dec lar ing of an operating loss) during such per iod. Ho wever, on ad jus ting f or the c apac ity dif f erence with respec t to indus tr y capac ity in a sys te matic manner, it c an le ad to the c le arer scenar io where f ixed costs are propor tiona tely reduced to present a be tter p ic ture of th e actual oper ating econo mic cond itio ns of the appellan t. It is qu ite cle ar f rom the d iscuss ions above tha t with ou t taking in to account the ef f ec ts of capac ity under u til is a tion and any adjustme n ts conco mitan t with such ef f ects, any evaluation of the ef f icienc y, marg ins or prof itabil ity, or indeed the ve ry wo rking env ironmen t pe culiar to the par ticular company canno t be sens ibly under taken a t any po in t of time.
The Hon'ble H ig h Cour t of Karnataka, in the c ase of T he Co mmiss ioner of Inco me Tax -8 V s. Pe tro Ar ald ite Pv t. Ltd. ( IT A No. 1540 of 2014), h as explained this issue in the f ollo wing ter ms.
" ... T he impugned order of the Tr ibun al records tha t th e d if f erence in c apac ity util isation wo uld af f ect the prof it marg in of a manuf actur ing concern. It po in ts out tha t the f ixe d overheads of any manuf ac tur ing concern will be cons tan t, irrespec tive of the c apacity util is ation. Thus, the prof it marg in wou ld be af f ected on ac coun t of the dif f erence in c ap ac ity u til is ation. Less util isation of capac ity , wo uld result in alloca tion f ixed cos ts over a s maller nu mbe r of f inal produc ts. Thus, reducing the pro f it marg in." (e mph as is added) Hav ing thus accepted that the ef f ec ts of capac ity und er-
u til is ation are an integral, ind ispensable and impor tan t par t of the an alys is of the econo mic/co mmerc ial wor k ing env ironmen t of an Assessee compan y, we f ind th at in the ins tant c ase suc h an env iron men t of capac ity under- u til is ation did indeed undisputedly ex is t d ur ing the impugned per iod on account of its in itial s tages of operation and the discuss ions, in relation to the ins talled and u tilised c ap ac ity , above."
5.1.2.Whe ther adjustme nt based on the fact of capacity under utilisation have any justification, roots or sanction in the various judicial precedents or not.
9 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 "T he appellant, in this connec tion, has c ited numerous c ase laws and judicial precedents that h ave underlined the need f or ad justmen ts based upon c apacity under-util is ation or tak ing in to ac coun t issues related to d if f erentials in c ap ac ity u til isa tion. I h ave c aref ully s tud ied the v ar ious judic ial pronouncemen ts cited by the appe llant in th is regard. Some of these are being disc ussed as under:
(a) T he H ig h Cour t of Karn ataka, in the case of Pr.
Co mmiss ioner of Inco me Tax -7 & Anr. V s.
M/s. Sami Labs ( I. T.A. No. 291/2017) , held th at:
"... We have heard the le arned AR as we ll as the le arned DR and cons idered the re lev an t mate r ial on record. The Tribun al f or the Assess men t Ye ar 2009-10 h as dir ected the AO/TPO/AO to cons ider the c laim of the assess ee f or the purpose of giv ing adjus tment o n ac coun t of lo w c apac ity ad jus tmen t. We make it c lear th at the adjus tmen t is only on ac count of cos t a ttr ibu table to id le capac ity f or the year under cons ider a tion. Acc ord ing ly, the assessee has to prov ide all the details of capac ity util is ation of assessee as well as co mpar able f or co mpu tatio n of adjus tmen t, if any. "
(b) The Coordinate Bench of ITAT, Kolkata in the case of Witzenmann India Pvt. Ltd. Vs. DCIT (2023) 148 taxmann.com 116 (Kol) has held that capacity utilisation had a co-relation with profits earned by the company since it leads to under-absorption of fixed costs and level of working capital have an impact on the prices charged and profits earned by Company. Claim of adjustment in respect of capacity utilisation and working capital levels should be considered after taking into account detailed working given by the assessee. The observation and finding given by the Co-ordinate Bench in para 12, 13, 16 and 17 are reproduced for ready reference (undersigned Accountant Member is the author for this decision):
10 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 " 1 2. Fr om the ab o ve s ub m i ss io ns an d m a te ri al pl ac e d o n rec or d, i t i s un di s p ute d t h at as se s see has uti l i ze d o nl y 22% of i ts i ns t al l ed c ap ac i t y i n t he y e ar u nde r c o ns id er ati o n. It i s al s o ev i de n t th at th e c o m p ar abl e s ar e at hi ghe r l e ve l s of c ap ac i ty ut il iz ati o n. T hes e f ac ts ar e i nco rp o r a te d i n t he t ab l e s r ep ro d uc e d ab ove. W e no te t hat c ap ac i ty uti l i z ati o n has a c o- r el at i o n wi t h the p rof it s e ar ne d b y a c om p an y si nc e i t l e ad s to unde r- abs or p t io n of f ix e d c o s t, m o re p ar ti c ul arl y whe n the MA M s el ec te d i s T N M M . Fur th er , we no t e th at FAT R i s n o t an i ndi c at o r of c ap ac i ty ut il iz ati o n of a c om p any. In re spec t of wo r k i n g c ap i t al ad ju s tm e nt, we no t e th at i t i s u nd isp ute d t h at as se s s ee h as a l o we r l evel of wo r k i n g c a pi t al as c om p ar ed to th e c o m p ar abl e s . A d m i tt e dl y , l ev el s of wo rk i ng c ap i tal hav e an i mp ac t o n the p ri c es c h ar ge d and th e pr of i ts e ar ne d by a c o m p any . In res p ec t of th e abov e t wo ad jus t m e nts , we n o t e th a t i t wo ul d b e ag ai n s t t he T P re g ul ati o ns and gu i d el i nes e num e r ate d ab ove to co m p ar e th e p rof its e ar n e d wi tho u t m ak i ng t hese e co no m i c ad jus t m e nts .
13. Fr o m r ul e 1 0B ( 3)( i i ) of the Rul es, we no te t hat a n unc o n tr ol l e d t r an s ac ti o n i s c o n si de re d to be c o mp ar abl e if no ne of the d if f er e nc es ar e l ike l y to m a te ri al l y af f ec t t h e pr i c e o r cos t c har g e d o r t he p rof it ar is i ng th e ref rom i n t h e ope n m ar ke t o r if reas o n abl e ac c ur at e ad ju s tm e nt c an be m ad e to e l i m i nate th e m ate r i al ef f ec t of suc h dif f erenc es, if th e y s o e x i s t. T hus , i t is r e aso n ab l e to i nf er f rom t he s ai d r ul e th at th e p u rp ose o r i nt e nt of t he c o m p ar ab il i t y an al y s is is to ex am i ne as to whe th e r o r no t v al ues s t a te d f or the i nte r nat i o n al tr ans ac t i o ns ar e at arm 's l e ng th i . e.
wh e th e r the pr i c e c har ge d i s c o m p ar abl e to th e p ri c e c h ar ge d unde r an un c o ntr ol l ed t r an s ac t i o n of sim il ar na tur e. T he pos i ti o n t hat e m e r ge s und er t he re gul at i o n i s th at if th er e ar e d if f erenc es wh i c h c an be adj us te d, the n ad jus t m e nts ar e r e qui r e d to be m ade an d al so t h at if t he dif f er e nc es b e t we e n t he c o m p ani e s are so m at e ri al t hat ad jus t m e nt i s no t p oss ib l e t he n c o m p ar abl e s are r e qui re d to be re j e c ted .
16. C o ns id er i ng t h e f ac t ual p o si t i o n de tail ed ab ov e an d th e p o s i ti o n of l a w as ref e rr ed i n ju di ci al pr e c e de n ts s t ate d ab ov e as we l l as u nde r t he r e gul ati o ns and gu i del i nes quo t e d he re i nabo ve , we agr e e wi th t he c ont e nti o n of t he Ld . C o uns el f or th e as ses see to pe rm i t m ak i ng ad ju s tm e nt i n r e sp ec t of cap ac i t y uti l i z ati o n an d wo r ki n g c ap i t al l ev el s vis - a- vi s t he c om p ar abl e s b as e d o n th e m e th o dol o g y ad op te d b y i t as r e p ro d uc e d h e r ei nab ov e . Ho we v er , i n t h e c o ur se of he ar i ng and al s o by way of wr i tt e n s ubm is si o n, Ld . C o uns el has p r e s sed upo n o nl y t wo gr ounds i. e. gr o und no s. 2 and 3( s up r a) wh i c h whe n tak e n u p i n ju x t apo si ti o n wi t h the f ind i ng gi ve n b y L d. C IT (A ) i n the l as t p ar a of hi s or d e r l e ad s to t he se l ec tio n of c omp ar abl es by L d. T PO an d c om p utat i o n of PL I th e reof has u nd is tu rbe d. As al re ad y s ta te d i n the ab o v e p ar agr ap hs , Ld . Cou nsel f or t he as se s s ee p re s se d o nl y o n Gr o un d N o. 2 a nd 3 and d i d no t m ake an y s ub mi ss io ns i n r e sp e c t of al l t he o t he r g ro un ds, th e s am e ar e d i s mi ss e d as s uc h.
11 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16
16. 1 W o rk i ng do ne b y th e as se ss e e i n res pec t of t wo abo ve s ta te d ad jus tm e nts i s b ase d o n th re e c o m p ar abl es o ut of th o s e s e l ec te d b y the L d. T PO and f our c om p ar abl e s o u t of th o s e se l ec te d b y the ass es se e . S i nc e the g ro un ds t ake n b y th e as se s s ee o n the sel ec tio n of c om p ar abl e s by th e Ld. T P O is no t p r es s e d upo n i n t he i ns t an t ap pe al and t he c ate gor i c al f indi ng o f the Ld . C IT (A ) o n t he s am e hol d i n g th e se l ec ti o n of c om p ar ab l e s b y L d. T PO as und is t ur be d, we f ind i t p ro pe r to di re c t th e L d. T PO I AO t o c o ns i de r t he c l aim of ad ju s tm e nt i n r esp ec t of c ap ac i t y u til i zat i o n and wo r k i ng c ap i t al l e ve l s so as t o al l o w ad jus t me n t t o th e prof it m ar gi n o n c o m p ar abl es s el ec te d by hi m ( T PO / A O) , af ter af f ordi ng th e as s es se e re as o nab l e oppo r tu ni ty of be i n g he ar d .
16. 2 In a s i tu ati o n whe r e the da t a abo ut c om p ar abl e c om p ani e s is no t a v ail abl e f or the p ur pose of al l o wi ng ad jus t m e nts t o wa r d s c ap ac i t y uti l i za ti on and wo r ki n g c ap i t al l ev el s, the o nl y way to ge t the d at a i n a c ur r e nt c as e wo ul d b e by L d. T PO c ol l ec ti ng t he s am e f r om t he c om p ar abl e c om p ani es s o s el ec te d b y h i m b y e xe rc i s i n g hi s po we r s U / S 13 3( 6 ) o f the A c t. Fo r thi s p r opos i ti o n, r el i anc e is pl ac e d o n th e dec i si o n of C oor di n at e be nc h of IT AT , M u mb ai i n t he c as e of f t. C IT v. K i ar a Je we l l e rv (P. ) L td. ( 2014) 45 t ax m ann . c om 5 48/ [ 2 015] 1 52 IT D 89 1 wh e re i n th e T PO / A O was d i r e c te d t o o b t ai n t he ex ac t de t ail s o n c ap ac i ty ut il i z at i o n of c o m p ar abl e c omp an i e s, if no t av ai l abl e i n p ubl ic d o m ai n . T he rel e v ant ex tr ac t of th e af o res ai d d e c is io n i s as un de r :
" 11. K ee pi ng i n v ie w t he d ec is io n of the T r ib un al i n th e c as e of P etr o A r al d i te (P . ) L td . (s upr a) l ayi ng do wn the gui del i ne s o n the iss ue of cap ac i ty ut il iz ati o n, we c o nsi de r i t ap p rop r i ate t o res to re t his iss u e r el ati ng t o ad j us t m e nt o n ac c o unt of cap ac i t y ut il iz ati o n i n t he c ase of ass ess ee c o m p any to the f il e of AO /T P O f or dec i di ng the s am e af res h kee pi ng i n v ie w t he s ai d gu id e l i ne s. If t he ex ac t de tai l s of c ap ac i ty ut il i z at i o n o f the co m p ar abl e c o m p ani es ar e no t av ai l abl e i n t he publ ic do m ai n , th e AO /T PO i s di re c te d to ob t ai n t he s am e d ir ec tl y f rom the c o nc e r ne d p ar ti e s and to d e c i de t hi s i ss ue af resh af te r gi v i n g as ses see an o ppo r t uni ty o n be i ng he ar d ."
17. A c c o r di ngl y , we al s o di re c t t he Ld. T PO to exe r c is e po we r s u / s. 13 3( 6) of th e A c t to c al l f or i nf orm ati o n o n c ap ac i ty ut il i z ati o n and wo r k i n g c ap i t al l e vel s of t he sel ec t e d c o m p ar abl e c om p ani es i n tho se c as es whos e d at a is no t av ail abl e i n publ i c do m ai n. Af t e r ob t ai ni n g t he i nf or m ati o n, the as s e sse e be give n an o pp or tu ni t y to p ut up i t c as e b y s h ar i ng de t ail s s o ob t ai ned and ac c o rd i ngl y gr ant the ad j us tm e n t f or c ap ac i ty ut il iz at i o n and wo r ki ng c ap i t al l ev el s. W e t hus , re m i t th e m at te r b ac k t o the f il e of Ld . T PO/ A O i n te r m s of o ur ab o ve di r ec t io ns an d t hus t he ap pe al of the ass e ssee is p ar tl y al l o we d f or s tat i s t i c al pu r p os e s . "
12 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16
(c) Asse ssee has placed on record a compendium of case laws, most of which have been discussed by the Ld. CIT(A) while dealing on this aspect. The table of cases is reproduced for ease of re fere nce:13 ITA No.233/Kol/2022
Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 5.1.3.Whe ther there is an express embargo upon the making of capacity utilisation adjustment with Rule 10B(1)(e)(iii) or in any other Rules of the Income-tax Rules, 1962 while working out the profitability parameters of an e nterprise:-
"Co ming f inally to the third par t of th is d is cuss ion o n whe ther there is an expres s embargo upo n the mak ing of capac ity util is a tion ad jus tments with in Ru le 10-B(1)(e)( iii) or in any o ther of the rules of the In come T ax Rules, 1962, wh ile workin g out the prof itabil ity par ame ters of an en te rpr ise. T his que s tion as men tio ne d above, has o ther assoc iat ed limbs to it. T he ques tion that needs to be addressed is whe ther the concep t of c ap ac ity util is a tion c an be r ead ou t of the provisions of the Inco me Tax A ct or Rules thereof . More precisely, f or the present co ntex t, can it be said that if a s ig n if ic ant d if f erence in capac ity util is atio n ex is ts in the c ase of the tes ted par ty - as in th is c ase - and the c ap ac ity util is a tion of uncon trolled par ties, then it is esse ntial, f or a har monious and mean ingf ul reading of the relev an t pro v is io ns of the Rules, to in c lude the ef f ect of capacity u nder-u til is ation on the marg ins or prof ita bility of the tes ted par ty in the work ing out of co mp ar isons be tween the tes ted par ty and the uncontro lled co mp ar ables and whether it c an be cons trued that Rule 1 0-B(1) (e) ( iii) of the Inco me Tax Rules, 1962 allows f or such ad jus tmen ts.
We have alre ady seen f rom the af oresaid dis cus s io ns that th is ques tion has already been ans were d in the af f irmative in the ple thor a of judic ial pronouncemen ts c ited and d iscuss e d above, where in the ju dic ial author ities hav e s anc tioned, in f act, mand ated, the f actor ing in of the ef f ect of under-util is a tio n of c apac ity in c ases wh ere compar isons are to be made with well 14 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 es tablished un con trolled concerns. This, it has 'been s tat ed, is f or prov id ing a suitable and realistic baseline f or the marg ins/ prof itabil ity of the tes ted par ty that is in a phase of underutil is ation of c apac ity. Let us now take a closer loo k at the relev ant Rules themse lves.
Bef ore looking a t the issue of adjustme n t f or dif f erence in c apac ity u til is a tion , it is necessary f irst to see the procedure laid do wn f or carrying ou t the exerc ise of compar abil ity analys is an d f or making suitab le adjus tments. This procedure, as laid do wn in sec tio n 92-C of th e Act, provides tha t the ALP in re lation to an in ter n ational tr ansac tion shall be dete r mined by any of the me thods specif ied therein, being the mos t appropr ia te me tho d and the manner in wh ich the said ALP has to be de ter mined is given in sectio n 92-C(2) of the Ac t read with Rule 10B of the Inco me T ax Ru les, 1962 in respe c t of each me tho d .separ ate ly. Clause (e) of Rule 10-B s tipulates the manner in wh ich the ALP in relation to an in te rna tion al tr ansaction is to be de ter mined by f ollo wing the tr an sac tional ne t mar gin me thod. The same is reproduced as under:
"(e) tr ans ac tio n al n e t margin me thod by wh ic h-
i) the ne t prof it marg in realised by the enterpr ise f rom an in ter n ational tr an sac tio n ente red into with an assoc iate d enter pr ise is computed in rela tion to cos ts incurred or sales ef f ected or asse ts employed or to be e mployed by the enterpr ise. or hav ing regard to an y o ther re lev an t base; -
ii) the ne t prof it margin realised by the en terpr ise or by an unrela ted enterpr is e f rom a compar able un contro lled tr ans ac tion or a number of such tr ansac tions is compu ted hav ing regard to the same base;
( iii) the ne t prof it marg in ref erred to in sub-clause ( ii) ar is ing in co mp ar able uncon trolled tr ansac tions is adjus ted to take into accoun t the dif f erences, if any, betwee n the in te rna tional tr ans ac tion and the co mpar able uncontro lled tr ans actions, or be twee n the en ter pr ises enter ing into such tr ans ac tions, which could mate r ially af f ec t the amoun t of net prof it margin in th e open mar ke t;
( iv) The ne t prof it marg in realise d by the en ter pr ise and ref erred to in sub-clause ( i) is establ ished to be the s ame as the ne t prof it marg in ref erred to in sub-c lause ( iii);
(v) The ne t prof it margin thus established is then taken in to accoun t to arr ive at an ar m's length pr ice in re latio n to the in ter n ational tr ansac tion;"
A plain re ad ing of the above rule clear ly br ings to f o re the f ac t that while re ly ing upon the TNMM me thod, the legis lature h as env is ag ed the necessity of br inging a tes ted par ty on to the same f ooting as the uncon trolled co mpar ables and f or th at purpose 15 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 prescr ibed the ma king of suitable ad jus tme n ts in the ne t prof it marg ins in order to cre ate a common bas e line f or making the co mp ar isons be twe en the tested par ty and the u ncon tr olled co m par ables. Sub-c lause ( iii) above clear ly mand ates the mak ing of adjus tments to ne t prof it margins to ta ke in to accoun t f actors " .. . whic h could ma ter ially af f ect the amo unt of net prof it margin in the open marke t."
The above d iscuss ions, relating to the o per ating bus iness env ironment of the tes ted par ty, as well discuss ions re lated to the judg ments in th is regard h ave c lear ly estab lished th at c ap ac ity under-u tilis ation is undispu ted ly a f ac tor th at would mate r ially ef f ect the ne t prof it marg ins of an capac ity underutil is ing entity . Theref ore we are led to the conc lus ion that s ince c apac ity util is a tion is undispu tedly a f ac tor whic h ma ter iall y eff ects marg ins and prof itability, it c an be construed that th ere wo u ld be no contr ad ic tion or unlawf ulness in us ing it to arr ive at a sens ible co mp ar ison as envisaged in Rule 10 B(e) and specif ically with in the me aning of subclass ( iii) of the said clause of the sub-ru le.
Once the matte r th a t there is nothing mater ially wrong or unlawf ul with the appe llan t's appro ac h of mak ing ad jus tmen ts f or c apac ity under u til isa tion is se ttled as per the above d iscuss ions, the nex t ques tion tha t ar ises is, in view the af oresaid prov is io ns of the re lev an t Ru le, ho w and to wha t ex ten t the d if f erence in c apac ity u til isatio n af f ects the pr of it margin and ho w the adjus tment on acc ount of dif f erence in c apacity util is atio n c an appropr iate ly be made. This question, n atur ally, has to be ans wered with in the f rame work of Rule 10B - that b e ing the governing Rule f or addressing such issues. I h ave examined the appe llan t's submissions in th is regard and f ind th at so me poss ib le appro aches to imple men t c apacity u til is ation ad jus tme nts are as under:
• Appro ach 1: Adjus ting f ixed costs of the tes ted par ty, kee ping sales and v ar iable cos ts u nchanged;
• Appro ach 2: Hypo thesising s ales and v ar iab le cos ts of the tes ted par ty to th e optimu m level of u til is ation, keep ing f ixed cos ts cons tan t; and • Appro ach 3: Adju sting the prof it marg in of the co m par ab les by absorbing deprecia tion of the compar ables at s ame r ate at wh ic h deprec iation is absorbe d by the tes ted par ty (b ased on gu id ance prov ided b y the Mumbai bench of the Inco me T ax Appe llate Tribunal in th e Fuc hs Lubr ic an ts ru ling).
S ince the d ata pe r taining to c apacity util is ation of comp ar ables is no t av ail able in th e public doma in, the only plaus ib le option f or mak ing ad jus tmen ts wo uld be to f ollo w Appro ach 1, we re the tes ted par ty d ata is adjus ted f or capac ity u nder-u til is ation. S ince var iab le cos ts is usually in propor tio n to the ac tual u tilis atio n or produc tion, no adjus tmen ts would be requ ired to be made to the 16 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 same. It is on ly the f ixed cos t th at con tinues be incurre d in f ull. It is th is cos t th a t re ma ins a constan t r igh t up to the time th at f ull c apac ity es tablishe d. With ref erence to the above d iscus s ions in th is contex t and the judic ial pronouncemen t in this re gard, it is cle ar that it is in the incurr ing of these f ixed cos ts th at adjus tments h ave to be made in rela tion to the actual util is atio n."
5.2. For the purpose of making adjustment on account of under-utilisation of capacity, assessee has submitted its working by adopting the two options i.e. first being adjustme nt on the fixed cost with capacity under-utilisation of teste d party at 34% and the second being adjusting the revenue and variable cost assuming that tested party was operating at the industry capacity utilisation leve ls of 73.19%. Both the options would give the same result on the adjusted margin which is tabulated as under:17 ITA No.233/Kol/2022
Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 5.3. By analysing the above three aspects e xhaustively, Ld. CIT(A) arrived at a conclusion to allow for the capacity utilisation adjustment for the purpose of benchmarking and de leted the addition made in this respect. Aggrieved, revenue is in appeal before the Tribunal.
6. Before us, Ld. CIT, DR contended that Ld. CIT(A) has not considered the unavailability of relevant financial data of comparable companies for allowing the appropriate capacity utilisation adjustment. He further submitted that the Act does not provide for any standardised method to arrive at the capacity utilisation adjusted PLI. According to him, to arrive at such an adjusted PLI, strong documentary evidence both, for the assessee and for the comparable companies are necessary condition to substantiate the adjustment to be made. Thus, in absence of all the relevant factual data for the comparable companies vis-à-vis the assessee, the capacity utilisation adjusted PLI arrived at is without proper verification and, therefore, the adjustment so made ought to be sustained.
7. Per contra, Ld. Counsel for the assessee reiterated the submissions made before the Ld. TPO as well as Ld. CIT(A).
He also placed on record the written submission in 11 pages along with a paper book containing 333 pages and a compe ndium of case laws, regulations and other supporting documents. Ld. Counsel made specific reference and emphasis in his submission in respect of provisions contained in the Act, permitting adjustment to be made towards capacity utilisation for arriving at the adjusted PLI.
18 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 He referred to Rule 10B of the Income-tax Rules, 1962 (hereinafter referred to as the "Rules") clause (e) sub-clause
(iii) which provide s that the net profit margin is to be adjusted to take into account the difference , if any, which could materially affect the amount of net profit margin in the open market. He further pointed to the said rule to submit that an uncontrolled transaction shall be comparable, if reasonably accurate adjustment can be made to eliminate the material effects of diffe rences, if any, between the transactions being compared.
7.1. According to the Ld. Counsel, guidance note on report u/s. 92E of the Act issued by Institute of Chartered Accountants of India (ICAI) also provides guidance and lists down specific entries which may affect the net margins and includes adjustment in respect of difference in the capacity utilisation level. He also referred to the transfer pricing guide lines for Multinational enterprise and Tax Administration by the OECD wherein at para 2.76, difference in capacity utilisation has been conside re d wherein it is stated that the transactional net margin method may be more sensitive than the cost plus or resale price methods to differences in capacity utilisation, because differences in the leve ls of absorption of indirect fixed costs (e.g fixed manufacturing cost or fixed distribution costs) would affect the net profit indicator but may not affect the gross margin or gross mark-up on costs if not re fle cted in price differences. He also referred to an important fact of start-up phase which has led to the adjustment for capacity utilisation in contrast to the year of incorporation of 19 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 comparables which has been tabulated to demonstrate that their operations had commenced much before the assessee was even incorporated. The table is reproduced as under:
7.2. He thus, emphasized that assessee has artificially made an adjustment towards its capacity utilisation being in start up phase, more particularly when the impugned year is the first full year of its manufacturing operation.
8. We have heard the rival conte ntions and perused the material available on record and given our thoughtful consideration to the submissions made by both the parties.
It is a fact on record that this is the first full year of manufacturing operation of the assessee and it is in its start-up phase. The comparables listed by the assessee and considered by the Ld. TPO are not in dispute. The dispute is in respect of adjustment made by the assessee towards its under-utilisation of capacity, being in the start-up phase.
20 ITA No.233/Kol/2022Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 The comparables as tabulate d above have commenced their operations much earlier to the asse ssee and are better place d towards their capacity utilisation. The capacity utilise d by the assessee during the year under consideration at 34% is also not in dispute. The industry average of capacity utilisation in the segment to which the assessee be longs, is 73.19% and has also been not controverted.
8.1. On an absolute basis, assessee is in the loss scenario, in the year under consideration. However, when capacity utilisation adjustment is made for the purpose of transfer pricing benchmarking of its international transactions with AEs its NCP margin comes to 11.66% which is comparable to the Indian comparable companies. What the Ld. TPO has done is that capacity utilisation adjustment made by the assessee has bee n disregarded and has arrived at the TP adjustme nt of Rs.1,69,80,694/-. From the perusal of records and material before us, assessee had adequately de monstrated from the data and the details, about the computation of the adjustment arrived at towards capacity utilisation.
8.2. Further, Ld. CIT(A) has elaborately dealt with the three aspe cts of the issue in hand before us which has been extracted above. The three aspects analysed by Ld. CIT(A) de als with the data and the computation mechanism adopted for the purpose of arriving at the adjustment, the judicial precedents which supports such adjustment and the various regulations in the law and other supporting documents, all of which convince us to hold that capacity utilisation 21 ITA No.233/Kol/2022 Kyocera CTC Precision Tools Pvt. Ltd.
AY: 2015-16 adjustme nt is a permissible adjustment vis-à-vis the comparables. We do not find any reason to interfere with the well reasoned findings give n by the Ld. CIT(A) in upholding the capacity utilisation adjustment made by the assessee and deleting the adjustment made by the Ld. TPO/AO in this respect. Accordingly, grounds taken by the reve nue are dismissed.
9. In the result, appe al of the revenue is dismissed.
Order is pronounce d in the open court on 2 n d June , 2023.
Sd/- Sd/-
(Rajpal Yadav) (Girish Agrawal)
Vice President Accountant Member
Dated: 2 n d June, 2023
JD, Sr. P.S.
Copy to:
1. The Appellant:
2. The Respondent:
3. CIT(A)-22, Kolkata
4. CIT, Kolkata
5. DR, ITAT, Kolkata Bench, Kolkata
//True Copy//
By Order
Assistant Registrar
ITAT, Kolkata Benches, Kolkata