Income Tax Appellate Tribunal - Delhi
Dcit, New Delhi vs M/S Munjal Showa Ltd.,, Gurgaon on 14 May, 2018
INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH "I-2": NEW DELHI
BEFORE SHRI AMIT SHUKLA, JUDICIAL MEMBER
AND
SHRI PRASHANT MAHARISHI, ACCOUNTANT MEMBER
ITA No. 3296/Del/2013
(Assessment Year: 2005-06)
DCIT, Vs. Munjal Showa Ltd,
Circle-5(1), 9-11, Maruti Industrial
New Delhi Area, Gurgaon
PAN: AAACM0070D
(Appellant) (Respondent)
Revenue by : Shri Ajay Vohra, Adv
Assessee by: Shri H. K. Choudhary, CIT DR
Date of Hearing 15/02/2018
Date of pronouncement 14/05/2018
ORDER
PER PRASHANT MAHARISHI, A. M.
1. This is an appeal filed by the revenue against the order of the ld CIT (A)-
XXIX, New Delhi dated 07.03.2013 for the Assessment Year 2005-06. The revenue has raised the following grounds of appeal:-
"1. Whether in the facts and circumstances of the case, the Ld. CIT(A) erred in allowing the adjustment on account of additional cost for development of new product without appreciating that the said purchase are from associate enterprises ?
2. Whether in the facts and circumstances of the case, the Ld. CIT (A) erred in allowing lower valuation of inventory of imported purchases without appreciating that the same were from associated enterprises.
3. Whether in the facts and circumstances of the case, the Ld. CIT (A) erred in restricting the capacity utilization adjustment to the extent of depreciation only ignoring the working done by the TPO.
4. Whether in the facts and circumstances of the case, the Ld. CIT (A) erred in allowing the exceptional replacement cost of Rs. 10.72 crores whereas the MOU between assessee and Honda Seil Cars limited provides for Rs. 6.11 crores.
5. That the order of the Ld CIT (A) is erroneous and is not tenable on facts and in law."
Page | 1 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06)
2. The assessee is a company engaged in the business of manufacture and sale of automobile components i.e. shock absorbers. It filed its return of income at Rs. 10,23,61,920/- and the assessment was made on 31/12/2008 by The Additional Commissioner Of Income Tax, Range 5, Delhi (Ld. AO) u/s 143 (3) read with section 92CA (3) of The Income Tax Act 1961 ( The Act) . The Ld. AO added an adjustment to the total income on account of the difference in the arm‟s length price ( ALP) of the international transaction of Rs. 22,66,12,074/-.
3. Brief facts of TP adjustment shows that assessee has entered into an international transaction with its associated enterprise for purchase of components and parts, purchase of capital goods, export of goods , payment of technical services fees, payment for royalty and payment for letter of credit. Assessee benchmarked these transactions adopting the Transactional Net Margin Method (TNMM) as the Most Appropriate Method. It adopted Profit Level Indicator of OP/sales selecting 49 comparables whose PLI was 4.22% based on the multiple year data and compared it with the PLI of the assessee at 4.18% and thus submitted that the international transactions entered into by the assessee are at arm‟s length price. The Ld. assessing officer perused the transfer pricing study report prepared by the assessee and issued show cause notice referring to several objections stating that assessee has selected comparable without taking into account the product similarity. He carried out the fresh search based on the product similarity and found that three comparable companies are available. He rejected others. Of the three comparable companies, he compared the profitability. Assessee objected that there are certain abnormal cost involved in the operation of the company such as product recall expenses amounting to Rs. 107232133/-, product import cost of product for a new product, inventory adjustments and capacity utilization which needs to be removed from the operating cost. Assessee submits that claim of the assessee is that these cost is on account of exceptional event. The Ld. Transfer pricing officer partially Page | 2 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) rejected the claim of adjustment of product recall expenses of Rs. 107282133/- holding it to be normal expenditure as per TPO. Assessee also submitted that it had to incur huge purchase expenditure on account of shock absorber to be supplied to HMSI which was required to be supplied by the assessee at the rate of Rs. 525/- per unit as new technology and components were not available therefore those were imported from its associated enterprise located in Japan and Thailand . As per assessee the cost of import was initially was Rs. 2825/- per unit which was reduced to Rs. 1632/- per unit afterwards in March 2005. Therefore, it was stated that the increased cost of import resulted in increased cost of production by Rs. 10.73 crores which may be allowed as deduction while computing the comparable margin of the assessee. The Ld. transfer pricing officer rejected the claim of the assessee for the reason that at the time of obtaining the contract of supply of shock absorber at Rs. 525/- per unit the assessee must have arrived at the sale price after taking into account the prevailing cost of component and technology. The Ld. TPO also noted that the assessee has failed to furnish any evidence for sudden unavailability and steep rise in cost of component and technology which could prove that the price setting mechanism of the assessee with regard to this of absorber went wrong. It was further noted by him that the import was made from associate companies and the assessee failed to prove if these imports were at arm‟s length price or not. The Ld. Transfer Pricing Officer also noted that assessee failed to substantiate its claim in absence of making CUP for identical products by the associated enterprise of the assessee to other parties. The assessee also sought an adjustment because of the downward revaluation of inventory with respect to Unicorn product. The Ld. Transfer pricing officer rejected the same. However the Ld. assessing officer Granted an adjustment of Rs. 6.11 crores on account of abnormal cost incurred by the assessee in relation to the supply of goods to Honda Seil Car Limited from the total cost incurred by the assessee of Rs. 517 Page | 3 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) crores. Based on the above adjustment the profit level indicator of OP/TC was calculated at 2.42 % and it were compared with the financial of the comparables where the Gabriel India Ltd (sole comparable retained) was computed at 4.70 %. The Ld. assessing officer further granted adjustment on account of capacity utilization of the comparable on the basis of the capacity utilization of the tested party. The Ld. Transfer pricing officer noted the capacity utilization of the assessee at 95.12% whereas the capacity utilization of the comparable was computed at 66.92 percentage and he computed the adjusted margin of the comparable at 6.69 %. Based on this he determined the arm‟s length price of the international transaction entered into by the assessee by considering the adjusted PLI at 6.69 % whereas the operating income of the assessee is Rs. 523 crores and arm‟s length profited adjusted profit ratio was considered at 35 crores and therefore he made adjusted book value of the profit at Rs. 12.34 crores and difference of 22.66 crores was suggested on account of the arm‟s length price of the international transaction.
4. Consequently assessment order under section 143 (3) read with section 92CA (4) of the Income Tax Act 1961 was passed on 31/12/2008 by the Ld. Assessing Officer at Rs. 334973994/- compared to the returned income of assessee of Rs. 108361920/- by making an adjustment on account of the transfer pricing adjustment of Rs. 226612074/-.
5. The assessee aggrieved with the order of the Ld. AO preferred an appeal before the Ld. CIT(A) -XXIX, New Delhi who vide order dated 7/3/2013 partly allowed the appeal of the assessee. The Ld. CIT(A) directed the Ld. Transfer Pricing Officer/AO to allow further adjustment over and above already allowed by the Ld. TPO of Rs. 6.11 crores on account of recall of products supplied to Honda car Limited by further sum of Rs. 4.60 crores. The Ld. transfer pricing officer was also directed by the Ld. CIT (A) to allow the additional cost of Rs. 10.73 crores on development of mono shock absorber as an abnormal expenditure in the appellants financial for Page | 4 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) the increased cost of raw material for new products. The Ld. CIT (A) also granted the assessee the relief of Rs. 2.56 crores on account of decrease in value of closing stock on account of valuation of inventory of „Unicorn‟. Accordingly he worked out the profit level indicator of operating profit/operating income of the assessee where the total cost was considered at Rs. 517 crores which was further reduced by the Ld. CIT (A) by abnormal cost of Rs. 24.01 crores resulting into adjusted total cost of Rs. 493 crores. The operating revenue of the assessee was Rs. 523.28 crores and the operating profit of the assessee was Rs. 30.24 crores which resulted into the profit level indicator of operating profit/operating income of 5.78 %. He also allowed the capacity utilization adjustment to the extent of the depreciation cost and held that as the profit margin of comparable company is 5.81% as against 5.78% of the appellant company the whole transfer pricing adjustment does not survive.
6. Aggrieved, by the order of the Ld. CIT (A) the revenue is in appeal before us. The main grievance of the revenue is the granting of the deduction of abnormal cost as product recall expenses, inventory valuation, and higher cost of purchases etc.
7. Assessee moved an application under Rule 27 of The Income Tax Appellate Tribunal Rules, 1963 stating that Renowned Auto Products Manufacturing Ltd ought to have been considered as a comparable for undertaking benchmarking analysis applying Transactional Net Margin Method. Ld. Transfer Pricing Officer while applying the transactional net margin method rejected it though it is also a shock absorber manufacturer, selected by the assessee as a comparable company, for the reason that the company has negative net worth during the year under consideration. Ld. Authorised Representative submitted that the Ld. CIT (Appeals) did not adjudicate upon the appropriateness of selection of this comparable as the adjustment made by the Ld. Transfer Pricing Officer was even otherwise deleted. Therefore, it was submitted that above company should have been considered as a comparable company Page | 5 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) for undertaking the benchmarking analysis applying the Transactional Net Margin Method. The Ld. Authorised Representative relied on the decision of the Hon‟ble Bombay High Court in case of B.R. Bamasi Vs. CIT 83 ITR 223 for the above contention. In view of this it was submitted that the Renowned Auto Products Manufacturers Limited should be considered as a comparable company for benchmarking of international transactions to determine the arms length price. To support the contention it was submitted that the sales and profitability trend of the comparable was having only negative net worth of Rs. 1.93 crores in financial year 2004- 05, however subsequently it resulted into the positive net worth. It was further stated that if the comparable company as contended by the assessee is included in the comparability analysis making two comparable companies, namely Gabrielle India Ltd and Renowned Auto Products Manufacturer‟s Ltd then, the average operating profit to sales margin of those comparable companies would be 2.78% whereas the operating profit to sales ratio of the assessee would be 2.42% and therefore the whole transfer pricing adjustment made by the Ld. Transfer Pricing Officer would obliterate.
8. Ld DR vehemently objected the application of the assessee under Rule 27 and stated that Rule 27 does not apply in the present case.
9. We have carefully considered the rival contention on this issue. According to us the assessee is eligible for contesting the issue of selection of comparable of Renowned Auto Products Manufacturers Limited. Undisputedly it is functionally comparable with the assessee. Therefore, on FAR analysis this company is one of the good comparable with the FAR of the assessee. Merely because that company has negative net worth in one year does not make it a non-comparable company. It has been shown before us that comparable has negative net worth only in FY 2004-05 and in subsequently it turned out to be in positive. In case of Negative net worth companies if selected by the assessee, it is the duty of the assessee to show that functional similarity between the comparable Page | 6 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) exists and the negative net worth of the company has no impact on the profitability of that comparable company. If the TPO rejects the comparable selected by the assessee, which is otherwise functionally comparable but has negative net worth, it is the duty of the TPO to show that negative net worth of the company has impacted its profitability in such a manner that its financial operations are not comparable with the assessee or its pricing has been adversely impacted due to it. Comparable having net worth can be rejected only when the parties prove that it has neither impacted Functions, Assets and Risk of the comparable and nor has impacted the pricing thereof. Neither party has shown before us that what affects the negative net worth of the comparable has made on its profitability for comparability analysis. Before the impact of negative net worth analyzed or questioned ld TPO has rejected the comparable. The identical comparable was accepted in the earlier assessment years in the case of the company and in one of the earlier years the whole issue has been set aside to the file of the ld DRP where one of the issue is of the selection of this comparable. Therefore in the back ground of past history in the case of the assessee with selection of this comparable, the issue is set aside to the file of the ld AO/ TPO with direction to decide the issue of the comparability of this comparable afresh after granting assessee an opportunity of hearing. Accordingly, the application of the assessee invoking Rule 27 of ITAT Rules is allowed.
10. Regarding the various grounds of appeal of the revenue, ld DR submitted that the additional cost of development of new products adjusted by the ld CIT(A) is devoid of any merit. He submitted that all these adjustment asked by the assessee is the normal business risk of the assessee, hence, same cannot be reduced from the operating cost. He further stated that assessee has entered into the agreement for supply of Rs. 525 per unit and assessee has also imported these absorbers from its associated enterprises at huge cost and therefore, same cannot be reduced. With Page | 7 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) respect to the capacity utilization also he relied upon the order of the ld Assessing Officer. He further objected that total extra ordinary cost which has been reduced by the ld CIT(A) from the total operating cost of the assessee is merely the normal business risk taken by the assessee.
11. The ld Authorised Representative submitted a written synopsis with respect to each of the adjustment in the operating cost. Regarding the recall of product supplied he referred to the copy of general purchase agreement between assessee and Honda Seil Cars India Ltd. He further referred to various correspondence between the parties and the details of product recall expenditure. He therefore, submitted that it has increased the cost of raw material to the tune of Rs. 2.54 crores. With respect to the order of development of new product he submitted a detailed technical report and stated that assessee agreed to sale the product at the aforesaid price with a view to retain the customer and to make a substantial sales by the assessee. He also submitted a chart which shows that in the subsequent years there is a growth @165%. With respect to the decrease in the value of inventory, he stated that above provision is as per AS-2 and the value of closing stock decreased by Rs. 4.77 crores because of special variety of shock absorber to be used in Unicorn Model of Honda Motorcycles. In view of this it was submitted that aggregate of the adjustment of aforesaid cost is required to be added to the operating profit of the assessee. He therefore, submitted that if then the margin of the assessee is compared with the Gabriel India, then operating profit of the assessee would be higher than operating profit of Gabriel India Ltd.
12. We have carefully considered the rival contentions and also perused the orders of the lower authorities. The assessee has asked for removal of certain cost from the operating cost of the assessee as according to it those costs have not been incurred in the normal course of the business but are extra ordinary items. In fact before deciding on removal of any cost component from the operating cost of the assessee for working out PLI, it needs to be verified whether the risk associated with the product Page | 8 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) in the case of the assessee as well as in the case of comparable is similar or not. The method of comparability adopted in TNMM which is tolerant enough to take care of expenses incurred by assessee as well as comparable with respect to normal business functions and risks. Therefore, if any expenditure claims to be extraordinary expenses which does not arise in normal course of business needs to be demonstrated with strict evidence and also to show that such risk and events do not normally undertaken by the comparables. The ld CIT (A) has dealt with the various such cost claimed by the assessee as under :-
"12.0 Finding:
12.1 1 have carefully considered various submissions made by the appellant. It is an accepted principle of transfer pricing regulations that suitable adjustments should be made to account for differences if any, between controlled international transaction and transactions of comparables or between enterprise entering into international transaction and comparable companies. Considering this cardinal principle, my findings with respect to issues involved are as under:
(a) Recall of products supplied to Honda Siel Car India Ltd.
12.2 The relevant facts are that during the previous year, M/s. Showa Corporation, Japan ("Showa") conducted a quality check of the products manufactured by the appellant. In the course of testing, it was observed that quality of the welding on the bottom tube joint with brackets manufactured and supplied by the assessee was not in line with the specifications / standards set by the customer M/s. Honda Siel Cars India Ltd. ("HSCI"). The appellant, therefore, decided to recall the aforesaid product as a good business practice and protect the will in the market. The aforesaid exceptional items of expenses relate to defective products, vis struts including bottom tubes, which were supplied by the appellant to HSCI.
12.3 The circumstances under which these expenses were incurred by the appellant are clearly exceptional or extra-ordinary. Therefore, in my view, the entire cost of Rs. 10,72,32,133 incurred on account of replacement of struts is to be treated as abnormal cost and is required to be excluded from the operating profit margin for application of TNMM. Out of the total expenditure of Rs. 10,72,32,133, adjustment was allowed by the TPO only to the extent of Rs. 6,11,62,246 on the basis that as per the MOU with HSCI, only expenses to that extent were required to be reimbursed by the appellant. The aforesaid finding of the TPO is incorrect. Out of the total expenditure of Rs. 10,72,32,133, incurred on replacement Page | 9 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) of defective parts supplied to HSCI, the TPO has only considered the portion of the expenses which was incurred at the end of the customer, viz., HSCI, and reimbursed by the appellant. The TPO did not take into account remaining amount of expenditure of Rs.4,60,69,887 incurred on recall of defective products at the end of the appellant. The entire expenditure incurred on recall of defective products supplied to HSCI of Rs. 10,72,32,133 is clearly reflected in the audited financials of the appellant as exceptional item. The assessing officer / TPO is accordingly directed to consider the entire expenditure of Rs. 10,72,32,133 as abnormal expenditure incurred on recall of defective products, viz., Struts (including bottom tube) supplied by the appellant to HSCI as abnormal item of cost which is not present in the financial of the comparable company, viz., Gabriel India Ltd. The remaining expenditure of Rs. 2.54 crores incurred on account of increased cost on account of import of bottom tube from Japan ensure continuous supply thereof is a routine operating expenditure incurred in the course of the business and cannot be treated as abnormal expenditure. The adjustment to the operating profit margin on account of recall of defective products supplied to HSCI, therefore, is to be restricted to Rs. 10,72,32,133 as against Rs. 13,26,32,133 claimed by the appellant. The assessing officer / TPO is directed to allow further adjustment to the extent of Rs. 4,60,69,887 in addition to Rs. 6,11,62,246 already allowed by the TPO.
(b) Development of new product for Honda Motorcycles & Scooters India Ltd.
12.4 During the relevant assessment year, the appellant has undertaken the contract for supply of special quality shock absorber, viz., Mono shock absorber, to be fitted in the Unicom model of two wheelers proposed to be launched by Honda Motorcycles & Scooters India Ltd. ("HMSI"). Unicorn two wheeler was proposed to be fitted with a single shock absorber instead of conventional two shock absorbers. The said product, viz., Mono shock absorber was being manufactured for the first time by the appellant and no one else has ever manufactured such shock absorber in India. It is a matter of fact that Gabriel, too, did not engage in manufacture of such kind of products in India.
12.5 I have examined various documents placed on record to demonstrate the extra ordinary circumstances in which the appellant had to incur higher cost in importing components to meet the stringent quality norms of the customer, viz., HMSI for manufacture of Unicom two wheelers. The monosock absorber was being manufactured by the appellant for the time in India. The monishiock absorber was, therefore, not being manufactured by Gabriel and is a unique product developed by the appellant. The cost of raw material including imported components, was at Rs.2,825 per unit initially and then to Rs. 1,632 in March 2005 (Presently at Rs.457.21 per unit), was higher than the price charged for Page | 10 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) the same. As a result, the cost of production of the Company increased by Rs. 10.73 crores.
12.6 The additional cost of Rs. 10.73 crores on development of monoshock absorber, therefore, is an abnormal item of expenditure in the appellant's financials and is accordingly to be excluded for computing operating profit margin for comparison with Gabriel.
(c) Decrease in value of closing stock on account of valuation of inventory of shock absorber for Unicorn at market price as against higher cost of production.
12.7 The appellant has submitted that it has undervalued the closing stock of monoshock absorber manufactured for Unicorn two wheelers by Rs. 4.77 crores as cost of production of such product was higher than the realizable value/market price. The aforesaid is purely an accounting adjustment which results in a mismatch of cost charged to profit and loss account and valuation of stock on the credit side of the profit and loss account. Such adjustment distorting the actual profit is required to be ignored for determining the operating profit margin for undertaking benchmarking analysis applying TNMM. I agree with the contention of the appellant that such distortion is required to be eliminated from the profit and loss account to recompute the correct operating profit margin from transactions entered into by the appellant. From the detail of valuation of closing stock furnished by the appellant, it was found that net realizable value (NRV) in respect of some items is in range of 90% whereas it is about 30% in respect of other items. Therefore, all the entries in valuation of closing stock do not represent extra-ordinary items. The total of extra-ordinary or abnormal items is found to be 2.56 crores which is required to be adjusted for working out profitability of the appellant.
12.8 In view of above, total extra-ordinary cost which is required to be adjusted is (10.72+10.73+2.56) 24.01crores. Accordingly, the working of PLI (operating profit / operating income) using figures taken by TPO shall be as under:
The total cost 517.05 Less: Abnormal cost 24.01 Adjusted total cost 493.04 Operating revenue 523.28 Operating profit 30.24 OP/OI 5.78%
ISSUE NO. 3: Whether action of AO/TP O in increasing operating profit margin of comparable Gabriel India Ltd. 6.69% from 4.71% on account of difference in capacity utilization is correct.
13.0 Appellant's Case:
Page | 11 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) 13.1 The TPO in his order computed the operating margin of Gabriel India Ltd at 4.71%. The TPO, however, further adjusted the operating profit of Gabriel to 6.69% allegedly on account of difference in the capacity utilization of the appellant and Gabriel India Ltd., as follows:
• Capacity utilization of the appellant is 95.12% • Capacity utilization of Gabriel is 66.92% • OP/OI of Gabrial = 4.71% • Adjusted margin of Gabriel at capacity level of 95.12% = 4.71 x 95.12/ 66.12 = 6.69% 13.2 The aforesaid adjustment made by the TPO for computing the operating profit margin of comparable company, Gabriel while applying TNMM is not appropriate for the reasons submitted as follows:
(a) The increase in the operating profit margin of Gabriel in proportion to the difference in capacity utilization is inappropriate inasmuch as the operating profit margin does not increase in proportion to the difference in capacity utilization. It would be appreciated that all expenses, viz., raw material cost, power and fuel cost, employees cost, manufacturing expenses, selling expenses, miscellaneous expenses, etc. do not significantly get influenced by the difference in the level of capacity utilization. Such operating expenses are generally commensurate with the volume of production and/or sales turnover and in case there is lower or higher sale, such expenses would correspondingly be increased or reduced. In other words, such operating expenses are normally commensurate with the level of sales. It would also be appreciated that the effect of high or lower capacity utilization is primarily reflected in the charge of depreciation, which is the major item of fixed cost in the profit and loss account in as much as other costs or expenses are incurred considering the operational capacity and are commensurate with the capacity actually utilized.
(b) Capacity utilization at best may provide the benefit to the appellant on account of lower incidence of depreciation as higher production is achieved using the same plant and machinery and other fixed assets.
Even considering the adjustment made on account of capacity utilization by adjusting the depreciation to that extent, the normalized profit and loss account of Gabrial India would reflect as under:
• Depreciation as per P & L A/c of Gabriel India = Rs. 15.23 crores • Adjusted depreciation = Rs. 15.23 x 66.12 / 95.12 = Rs. 10.59 crores Finance- Profit and Loss-Gabriel India Ltd (Rs in Cr.) INCOME:
Page | 12 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) • Sales Turnover ^ 477.86 • Excise Duty 64.61 • Net Sales '413.25 • Stock Adjustments 5.09 Total Income 418.34 EXPENDITURE • Raw Materials 254.7 • Power & Fuel Cost 10.9 • Employee Cost 31.14 • Other Manufacturing Expenses 44.73 • Selling and Administration Expenses 38.48 • Miscellaneous Expenses 3.47 • Less: Pre-operative Expenses Capitalized 0 • Depreciation 10.59 • Total expenditure 394.01 Operating Profit 24.33 OP/ OI %) 5.81 Further, it is submitted that after adjustment to operating profit of the assessee company on account of abnormal costs, operating profit ratio is worked out to 7.61% as against the operating profit ratio of Gabriel India Ltd at 5.81%. Therefore the international transactions entered into by the appellant are, considered as having been undertaken at arm's length price, applying TNMM and adjustment is required on this account
(c) Alternatively, the aforesaid adjustment on account of level of capacity utilization can be made in the operating results of the appellant as follows:
• Capacity utilization of the appellant is 95.12% • Capacity utilization of Gabriel is 66.92% • OP/OI of Gabrial = 4.71% • OP/OI of the appellant (as computed by the TPO) is 2.42% • Adjusted operating profit margin of the appellant at capacity level of 66.92% = 2.42 x 66.92/95.12= 1.68% • The difference in operating profit margin works out to 3%.
Considering the difference in operating profit margin of 3% as aforesaid, the adjustment would be worked out at Rs. 15,69,84,000 as against Rs.22,66,12,074 computed by the TPO.
14.0 Finding:
Page | 13 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) I have duly considered various contentions raised by the" appellant. It is a matter of common understanding that operating profit margin of - a manufacturing enterprise does not vary in direct proportion of the variation in capacity utilization. All variable cost, such as, raw material cost, power and fuel cost, employees cost, manufacturing expenses, selling expenses, miscellaneous expenses, etc. do not significantly get influenced by the difference in the level of capacity utilization. Such operating expenses are generally commensurate with the volume of production and/or sales turnover and in case there is lower or higher sale, such expenses would correspondingly be increased or reduced. In other words, such operating expenses are normally commensurate with the level of sales. It would also be appreciated that the effect of high or lower capacity utilization is primarily reflected in the charge of depreciation, which is the major item of fixed cost. The increase in operating profit margin of Gabriel on a straight-line basis, directly in proportion to the difference in capacity utilization of the appellant and of the Gabriel, in my view, is inappropriate and is not consistent with the accepted principles of commercial accountancy. Capacity utilization at best may provide the benefit to the appellant on account of lower incidence of depreciation as higher production is achieved using the same plant and machinery and other fixed assets. After making capacity utilization adjustment to the extent of depreciation cost, the profit margin (OP/OI %) of Gabriel India Ltd. would work out to 5.81% as against 5.78% of the appellant. Adjusted operating profit margin of the appellant being within prescribed range of operating profit margin of Gabriel, the international transactions entered into by the appellant is considered as having been undertaken at arm's length price and adjustment made by the TPO of Rs.22,66,12,074 does not survive. The AO is therefore directed to delete the addition made under transfer pricing adjustement."
13. The assessee has submitted the copies of the orders of the coordinate bench in its own case for AY 2006-07 and 2007-08 wherein in para No. 6 of the order for AY 2006-07 identical reference is for capacity utilization, extra ordinary items and non operating expenses. The coordinate bench has set aside the whole issue back to the file of the ld DRP as para no 10 of the order as it was a non speaking order.
14. The first issue of the reduction of Product recall expenses of Honda Seil Car India Limited. The product manufactured by the assessee failed the quality check conducted by its parent company. Based on the finding of the parent company assessee recalled the products sold to Honda Seil car India Limited. Based on it assessee submitted that it has incurred the Page | 14 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) expenses of Rs 10.72 Crores which needs to be removed from the operating cost. Ld TPO allowed the reduction to the extent of Rs 6.11 crores . The ld CIT (A) accepted the reasoning of the asssessee and allowed the full deduction of Rs 10.72 crores of above cost. Product recall expense has been shown by the assessee as extra ordinary cost in schedule 22 of the annual accounts. Reference has also been given in note no 10 of schedule 24 of the accounts. Even ld TPO has accepted this fact that this expenses needs to be adjusted while working out PLI but he adjusted partially only. The adjustment made by the ld Transfer Pricing Officer was based on the copy of the memorandum of understanding produced between assessee and Honda Seil Cars Ltd dated 24.02.2005.
According to those clauses of MOU only 12795 cars were impacted and to this extent the assessee was to bear the loss which amounts to Rs. 6.11 crores. The ld Transfer Pricing Officer granted the above deduction from the overall cost of the assessee as extraordinary cost. Before the ld CIT(A) the assessee submitted that assessee has incurred total cost of Rs. 10.72 crores whereas the TPO considered only the expenses which were incurred by the customer and reimbursed by the appellant. We concur that the assessee over and above the direct expenditure as reimbursement to the customer has other expenditure also in the form of goods lying at the factory. Infact the claim of the assessee is Rs. 13.26 crores out of which the ld Transfer Pricing Officer allowed Rs. 6.11 crores and ld CIT(A) enhanced the deduction to Rs. 10.72 crores. The above facts shows that there is an extraordinary event which has resulted into impacting the overall cost of the assessee. Further, with respect to the overall expenditure the certificate of the appellant shows the total cost at Rs. 10.72 crores at page No. 12 of the order of the ld CIT(A) which remains undisputed. Therefore, to this extent no infirmity can be found in the order of the ld CIT (A) in granting the above reduction. In the result Ground no 4 of the appeal of revenue is dismissed.
Page | 15 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06)
15. Further assessee has also stated that it has undertaken a contract for supply of new type of shock absorber in „Unicorn„ motor cycle manufactured by HMSI. For which assessee has incurred higher cost of material procurement then what was the price contacted for supply of goods. The ld. AO/ TPO did not accept the claim of the assessee. The ld CIT (A) held it to be extra ordinary expenses item. According to us it is merely a transaction of purchases of import of goods at higher price and its resale to the principal at lower prices. The product are also imported from the Associated concerns. The above loss has been incurred by the assessee as a normal businessperson unless the assessee demonstrates some extra ordinary factors attached to it other than normal business risk elements. Merely because the assessee is supplying a product for a new vehicle, when assessee is in the same line of business for a long time, coupled with the fact that products have been imported from the sister concern for onward supply to the principle and later on of prices stabilized, does not make assessee to say that these cost are extra ordinary cost . It is merely a transaction of purchase and sales of goods which has resulted in to lesser profit to the assesee in its business. Assessee has also stated that it is increased cost of production only. Cost of production is the normal activity. No such disclosure is also made in the annual accounts to this effect also. This is a result of normal business risk of the assessee and hence same cannot be reduced from the total cost. Hence, the reduction granted by the ld CIT (A) of Rs 10.73 crores is not proper. The action of ld CIT (A) is reversed and order of TPO is restored to that extent. In the result Ground no 1 of the appeal of the revenue is allowed.
16. The third adjustments was on account of adjustments of the value of the inventory of Rs. 4.77 crores and CIT (A) allowed it to the extent of Rs 2.56 crores on account of valuation of inventory of „Unicorn‟ products. The resultant adjustment was sought by the assessee submitted that the value of the inventory is less than the cost incurred by the assessee.
Page | 16 DCIT Vs. Munjal Showa Ltd, ITA No. 3296/Del/2013 (Assessment Year: 2005-06) The method of valuation of inventory shown by the assessee is at note no (g) of schedule 24 which shows that inventories are to be valued at „ cost or net realizable value whichever is less‟. This is the method of accounting and valuation of inventory regularly followed by the assessee and the risk of diminution in the value is inherent in any business. Further, the assessee has also not classified it as exception or extra ordinary loss. The inventory has also not been sold. The ld CIT (A) has also gone on estimates without identifying any extra ordinary losss in the inventory but has gone on percentages which is not acceptable. The Differential prices were also calculated by applying the rates of the prouct and not identifying each of the components, which is mandatory at the time of valuation of goods. Assessee before TPO has stated that due to this profit is lowered by 0.79 %. The ld TPO has also given his reason in para no 5.3.3. of his order. He held that no such adjustment was made in Rule 10 D documentation. As the complete fact of the issue, identifying each products and its valuation and consequential shortfall and whether it is an extra ordinary items as per TP documentation is not coming out , Hence this issue is set aside to the file of the ld TPO/AO to decide afresh . Ground no 2 of the appeal is allowed for statistical purposes.
17. Regarding capacity utilization level in the case of the assessee as well as the comparable company, we do not find any infirmity in the order of the ld CIT (A) who allowed it only with respect to depreciation. Hence, Ground no 3 is dismissed.
18. Accordingly, application of assessee under rule 27 of ITAT rules, 1963 for inclusion of Renowned Auto products manufacturing Co Limited is allowed and appeal of the revenue is partly allowed for statistical purposes. Order pronounced in the open court on 14/05/2018.
-Sd/- -Sd/-
(AMIT SHUKLA) (PRASHANT MAHARISHI)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Page | 17
DCIT Vs. Munjal Showa Ltd,
ITA No. 3296/Del/2013
(Assessment Year: 2005-06)
Dated:14/05/2018
A K Keot
Copy forwarded to
1. Applicant
2. Respondent
3. CIT
4. CIT (A)
5. DR:ITAT
ASSISTANT REGISTRAR
ITAT, New Delhi
Page | 18