IT(TP)A No.1494(B)/2010 IN INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCH B , BANGALORE BEFORE SHRI S.K.YADAV, JUDICIAL MEMBER AND SHRI A. K. GARODIA, ACCOUNTANT MEMBER IT (TP) No.1494(Bang) 2010 (Assessment year : 2006-07) M/s Molex India Tooling Pvt. Ltd., Plot No.6A, Sadarmanagala Industrial Area, Bangalore -560 067 Pan No.AACCM6091N/MA-336 Appellant Vs Deputy Commissioner of Income Tax, Circle-12(1), Bangalore Respondent Assessee by : Shri P.K Prasad, CA Revenue by : Ms. Neera Malhotra, CIT Date of hearing : 03-08-2016 Date of pronouncement: : 18-10-2016 ORDER PER SHRI A.K.GARODIA, AM This is assessees appeal directed against assessment order passed by AO on 22-09-2010 u/s 143(3)r.w.s.144C(5)r.w.144C(8) of IT Act, 1961 as per directions of DRP. 2. grounds raised by assessee are as under; IT(TP)A No.1494(B)/2010 With respect to international transactions entered into by Molex India Tooling Private Limited (hereinafter referred to as "Appellant"), reference was made under provisions of Section 92CA by Assistant Commissioner of Income-tax, Circle - 12(1) post obtaining approval of Commissioner of Income-tax, Bangalore - III. Transfer Pricing proceedings were taken up subsequent to aforementioned reference and learned Transfer Pricing Officer ("TPO") after taking into cognizance various submissions made by Appellant, made adjustment of Rs.58,553,403 in respect of international transactions entered into by Appellant u/s 92CA of Income Tax Act. Aggrieved by such adjustment to Arm's Length Price (hereinafter referred to as "ALP") as originally determined by Appellant, appellant took recourse to Dispute Resolution Panel ("DRP") as constituted under Income-Tax Dispute (Resolution Panel) Rules, 2009. As provided under said Rules, appellant filed comprehensive set of objections set out under various grounds against order passed by learned TPO. Honourable DRP, subsequent to providing opportunity for appellant to represent case before Panel, passed order dated 22nd September, 2010, upholding contentions and consequently adjustment to ALP as made by TPO. IT(TP)A No.1494(B)/2010 Subsequently, order was passed by learned Assessing Officer (hereinafter referred to as "AO") dated 22nd October, 2010 (received on 28th of October 2010 by Appellant), under sub section (3) of section 147 in pursuance of directions of Honourable DRP. I. Transfer Pricing appellant wishes to state that Honourable DRP and learned AO grossly erred in upholding income adjustment proposed by learned TPO in arriving at ALP of international transactions entered into by appellant. appellant is in appeal before honourable bench of Income Tax Appellate Tribunal (hereinafter referred to as "ITA T") under section 253 (1) (d) against order passed by learned AO in pursuance of directions of Honourable DRP. 1. Adjustments for material differences Honourable DRP and learned AO have erred in accepting contention of TPO that transactions are not at arm's length price. Honourable DRP and learned AO have erred in accepting contention of TPO, wherein TPO has rejected quantitative adjustments provided by appellant for differences in production capacity utilised by appellant and comparable companies. IT(TP)A No.1494(B)/2010 Honourable DRP and learned AO have erred in accepting contention of TPO, wherein TPO has provided adjustments only in respect of depreciation costs and no adjustments for expenses which are fixed in nature for difference in production capacity utilised by appellant and comparable company. 2. Gross Margin Analysis Honourable DRP and learned AO have erred in rejecting gross margin analysis provided by appellant. 3. Use of contemporaneous data Honourable DRP and learned AO erred in concluding that appellant ought to have employed contemporaneous data in preparation of Transfer Pricing report. This argument of Honourable DRP is not valid on principle of fairness and natural justice, as appellant cannot be expected to use data that is unavailable in databases at time of preparing documentation. Honourable DRP and learned AO erred in interpreting word "Shall" in Rule 1OB (4) to mean that data for same financial year in which international transaction was actually entered into is mandatory requirement. Also appellant wishes to submit that Honourable DRP and learned AO ought to have appreciated that transfer pricing regulations provide contemporaneous documentation to be mandatory, and not use of data for same financial IT(TP)A No.1494(B)/2010 year. Honourable DRP and learned AO ought to have appreciated fact that objective underlying use of multiple-year data was to ensure that outcomes of international transactions for year under consideration were based on all earlier periods which were relevant for determination of transfer price. Moreover data of preceding two financial years gives clear indication of business and economic conditions prevailing at beginning of relevant financial year i.e. time when transfer prices are set up, and purpose of using multiple year data is to minimize and even out impact of any abnormal factor which might have unduly influenced outcomes of data used for comparability analysis. 4. Safe harbour and application of +=5% Arm s Length range Hon ble DRP and ld. AO have erred in supporting learned TPO s misinterpretation that amended provision regarding provision of arm s length range as per Finance Act, 2009 was applicable to financial year (FY) 2005-06 as well. Hon ble DRP and ld. AO ought to have considered fact that amendment was introduced with effect from 1st October 209 and said amendment was not retrospective in nature. Further, amendment is substantive in nature and not merely procedural. It is accepted legal IT(TP)A No.1494(B)/2010 position that changes of substantive nature cannot be construed to be retrospect5ive, unless expressly provided by statute. Therefore, amendment to Sec.92C should not be interpreted to cover assessment year 2006-07. This is further supported by CBDT Circular No.05/2010 dated 3rd June 2010, which clarifies that amended safe harbor provisions are applicable to assessments for year ended 31 March 2009. Without prejudice to any of appellant s other grounds of appeal, if at all any adjustment is made, same should be made only to lower limit of 5% range set out u/s 92C(2). appellant craves leave to add, alter and modify above grounds during course of appeal. For above and any other grounds which may be raised at time hearing, it is prayed that order of learned AO be set aside. ld. AR of assessee submitted copy of synopsis containing all arguments of assessee before Tribunal and same is reproduced herein below: SYNOPSIS 1. Background: 1.1. Molex India Tooling Private Limited ('MITPL' or 'Appellant') was engaged in manufacture of machine tools, tooling spares, housing, dies and moulds and commenced commercial production on March 1, 2002. IT(TP)A No.1494(B)/2010 1.2. Due to underutilization of production capacity, Appellant suffered losses during financial year ('FY') 2005- 06. 2. Proceedings before learned Transfer Pricing Officer (,TPO,): 2.1. Appellant, during Transfer Price ('TP') assessment, submitted that it was in start-up phase and consequently, production capacity was underutilized. Accordingly, Appellant submitted Gross Margin analysis establishing arm's length nature of international transactions undertaken by Appellant. 2.2. Further, Appellant provided computation of operating cost mark-up of comparables post adjusting for differences in production capacity utilized by Appellant and comparable companies ('capacity utilization adjustment'). 2.3. learned TPO acknowledged difference of underutilization of production capacity between Appellant and comparable companies, and considered ratio of Profit before Depreciation, Interest and Taxes ('PBDIT') to Total Operating Cost excluding depreciation ('PBDIT / TC') as Profit Level Indicator ('PU'). Hence, learned TPO computed Appellant's PLI to be ( -) 31.46%. 2-4. learned TPO arrived at comparable PLI of 18.80% and provided adjustment of INR 5,70,01,235/-. 2.5. In addition to above, learned TPO determined arm's length price of transaction of purchase price of raw materials, production supplies and spares. In this regard, learned TPO computed arm's length price for aforementioned transaction as follows: Amount Particulars (INR) Purchase price of raw materials, production 37,29, spares 591 Sales in proportion to above purchases 25,56, [(100%-31.46%) ofINR 37,29,591] 261 Arm's Length Margin on Sales (PBDIT / TC) 14 82 Arm's Length Price of aforementioned 21,77, purchases [(100%-18.80%) ofINR 25,56,261] 423 IT(TP)A No.1494(B)/2010 Accordingly, learned TPO provided adjustment of INR 15,52,168/-. 2.6. Therefore total adjustment provided by learned TPO was INR 5,85,53,403/-. 3. Proceedings before learned Dispute Resolution Panel {'Panel'] 3.1. learned Panel upheld action of learned TPO and dismissed objections of Appellant. 4. Proceedings before Honorable Income-tax Appellate Tribunal (,Tribunal') 4.1. Appellant would like to humbly submit before Honorable Tribunal that learned TPO erred in not providing capacity utilization adjustment and changing PLI from Operating Cost Mark-up to ratio of PBDIT / TC when depreciation is essential component of operations, it being related to machinery used for manufacturing activity. Also, learned TPO erred in only considering depreciation cost as fixed without considering other fixed costs of Appellant. 4.2. Appellant also would humbly submit before Honorable Tribunal that while computing PLI of Appellant, transaction of purchase of raw materials, production supplies and spares was considered. adjustment to PLI of Appellant was already provided. Therefore, adjusting aforementioned transaction tantamounts to double adjustment. 4.3. Further, Appellant wishes to humbly submit before Honorable Tribunal that annual reports of Guindy Machine Tools Limited and United Drilling Tools Limited were not available during preparation of TP Study and accordingly, was not considered while computing arm's length price. Annual Reports of aforementioned com parables are now available and hence, should be included in list of comparables while determining arm's length price. (Please refer to page no 4 & 10 of Appendix 3 of TP Study and page no. of 636 to 700 of Annual Report Compendium submitted before Honorable Tribunal). IT(TP)A No.1494(B)/2010 In addition to above, Appellant humbly submits that aforementioned comparables were also considered while preparation of TP Study for FY 2004-05 and same were accepted by learned TPO and learned Commissioner of Income-tax (Appeals) as com parables to Appellant. 4-4. Appellant further submits that Electronica Machine Tools Limited ("EMT") is engaged in trading activity in addition to manufacture of machines and tungsten carbide products. Furthermore, EMT has amalgamated with Electronica Plastic Machines Pvt. Ltd., which is involved in manufacturing machines used to manufacture moulds, during year, thereby tantamounting to extraordinary activity. Accordingly, making EMT functionally not comparable to Appellant and consequently, ought to be rejected from set of comparable companies (Please refer to page no. of 465, 489 & 490 of Annual Report Compendium submitted before Honorable Tribunal). 4.5. Furthermore, Appellant submits before Honorable Tribunal that Kulkarni Power Tools Limited ("KPT") is engaged in activities of manufacturing and trading of power tools and blowers. In addition to aforementioned activities, KPT is also involved in distribution of electricity. Further, segment financial information is not available during year. Accordingly, making KPT functionally not comparable to Appellant and consequently, ought to be rejected from set of comparable companies (Please refer to page no. of 520, 529 & 530 of Annual Report Compendium submitted before Honorable Tribunal). 4.6. Furthermore, Appellant submits that operating cost mark-up of Appellant and comparable companies computed by learned TPO was erroneous, consequently, Appellant submits correct computation before Honorable Tribunal. 4.7. Furthermore, learned TPO / learned DRP did not provide adjustment with respect to differences in working capital between comparable companies and Appellant. Accordingly, Appellant humbly submits before Honorable Tribunal that adjustment to operating profit to operating cost of com parables ought to be provided towards difference in working capital levels of comparable companies and Appellant. IT(TP)A No.1494(B)/2010 4.8. Appellant relies on ruling of 24/7 Customer Con Pt. Ltd. [ITA.227/Bang/20101 wherein Honorable Tribunal has accepted additional ground filed by Appellant seeking economic adjustment and where such claim was not placed earlier during transfer pricing assessment or appellate proceedings. 4.9. Appellant humbly submits that capacity utilization adjustment is to be provided on fixed costs of comparable companies. Similar directions have been provided by various Tribunal in case of Claus India Pvt. Ltd. [ITA No. 1783/ DEL / 20111 and Petro Araldite Pvt. Ltd. [ITA No. 3782/ MUM /2011]. 4.10. Further, Appellant humbly submits that capacity utilized by Appellant and comparable companies computed earlier were erroneous. Accordingly, Appellant has computed correct capacity utilized as per ruling of Panasonic AVC Networks India Pvt. Ltd. [ITA No. 4620/ DEL / 20111. 4.11. Following above mentioned rulings and contentions, Appellant has computed average operating cost mark-up of comparable companies considering capacity utilization adjustment at (-) 88.24%. 4.12. operating cost mark-up of Appellant has been correctly computed at (-) 46.03% which is higher than adjusted average operating cost mark-up of comparable companies and therefore, is at arm's length. 4.13. Further, Appellant wishes to humbly highlight before Honorable Tribunal that during course of TP Assessment for AY 2007-08 of Appellant, learned TPO has considered underutilization of capacity and held that transfer price of international transactions undertaken by Appellant to be at arm's length . We have considered rival submissions. We find that apart from request of assessee for inclusion of two comparables and exclusion of two comparables, main grievance of assessee is regarding non-granting of adjustment on account of lower capacity utilization and working capital adjustment. In this regard reliance has been placed by ld. AR of assessee on various judicial pronouncements noted in synopsis reproduced above. For exclusion of Electronica Machine tools Ltd., and Kulkarni Power Tools Ltd., assessee pointed out annual reports of these two companies on issue regarding these two companies raised by way of filing additional grounds. Regarding inclusion of two companies i.e M/s Guindy Machine Tools Ltd., and M/s United Drilling Tools Ltd., It has been submitted before us that these companies were rejected because unavailability of data, but since data of these two companies are now available in annual report of these two companies, these two companies should be considered as good comparables. In view of these facts, we are of considered opinion that issue regarding inclusion of these two companies should go back to file of TPO/ AO for fresh decision. We order accordingly. Regarding adjustment on account of lower capacity utilization and working capital adjustment, we find that it is noted by DRP in para-3.2 on page-3 of its order that TPO highlighted major cost 12 IT(TP)A No.1494(B)2010 shown in P&L account was depreciation which in case of tax payer was about 20% of total cost against average of 3.5% in case of comparables. Thereafter, it is noted by DRP that neutralize this difference TPO has considered PBDIT as PLI by following Tribunal order in case of Sechefenacker Motherson Ltd., Vs ITO(2009-TIOL-376-ITAT-Delhi. It is further noted by DRP in same para with regard to claim of assessee for other costs such as employee cost, repair and maintenance cost, office supplies, filing fee etc., It has been observed by TPO that these cases are slightly higher than comparables in ratio of about 7 to 6 but just because costs were higher, adjustment could not be considered. In light of these facts, now we consider applicability of various judgments cited by ld. AR of assessee on this issue. First judgment cited is Tribunal order rendered in case of CIT Vs Class India Pvt.Ltd., in ITA No.1783/Del/2011 dated 12-08- 2015. Copy available on pages 701 -726 of paper book, para no.9.3 to 10.2 of this Tribunal order available on pages 714 to 720 of paper book are relevant for present issue in dispute hence, these paras are reproduced herein below for sake of ready reference; 9.3. Sub-rule (2) of Rule 10B provides that comparability of international transaction with uncontrolled transaction shall be judged with reference to certain factors which have been enumerated therein. Rule 10B(3) states that uncontrolled transaction 13 IT(TP)A No.1494(B)2010 shall be comparable to international transaction, if either there are no differences between two or reasonably accurate adjustment can be made to eliminate 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, position which emerges is that net operating profit margin of comparable companies calls for adjustment in such manner so as to bring both international transaction and comparable cases at same pedestal. In other words, if there are no differences in these two, then average of net operating profit margin of comparable companies becomes benchmark. However, in case there are some differences between comparables and assessee, then effect of such differences should be ironed out by making suitable adjustment to operating profit margin of comparables. That is way for bringing both transactions, namely, international transaction and comparable uncontrolled transactions, on same platform for making meaningful and effective comparison. above analysis overtly transpires that law provides for adjusting profit margin of comparables on account of material differences between international transaction of assessee and comparable uncontrolled transactions. It is not other way around to adjust profit margin of assessee. In other words, net operating profit margin realized by assessee from its international transaction is to be computed as such, without adjusting it on account of differences with comparable 14 IT(TP)A No.1494(B)2010 uncontrolled transactions. adjustment, if any, is required to be made only in profit margins of comparables. 9.4. Reverting to facts of instant case, we find that authorities below have adjusted operating costs of assessee in allowing capacity adjustment. As against that, correct course of action provided under law is to adjust operating costs of comparable and their resultant operating profit. There is hardly need to accentuate that there can be no estoppel against law. Once law enjoins for doing particular thing in particular manner alone, it is not open to anyone to adopt contrary or different approach. As authorities below have adopted course of action in allowing adjustment, which is not in consonance with law, we cannot approve same. impugned order is set aside and matter is restored to file of TPO/AO for giving effect to amount of idle capacity adjustment in operating profit of comparables and not assessee. ii. How to compute capacity utilization adjustment under TNMM : - 10.1. Under TNMM, ALP of international transaction is determined by computing and comparing percentage of operating profit margin realized by assessee with that of comparables. We have noticed 15 IT(TP)A No.1494(B)2010 above that difference in capacity utilizations is important factor, which needs to be adjusted. No mechanism has been given under Act or rules for computing amount of capacity utilization adjustment. 10.2. On overall understanding, we feel that under TNMM, first step in granting capacity utilization adjustment is to ascertain percentage of capacity utilization by assessee and comparables. There can be no difficulty in working out these percentages. second step is to give effect (positive or negative) to difference in percentage of capacity utilizations of assessee vis- -vis comparables, one by one, in 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 fixed part and variable part. In so far as variable costs and variable part of semi-variable costs are concerned, these remain unaffected due to any under or over utilization of capacity. Accordingly, such variable operating costs remain unchanged. adjustment is called for only in respect of fixed operating costs and fixed part of semi-variable costs. Such costs are scaled up or down by considering percentage of capacity utilization by assessee and such comparable. It can be illustrated with help of simple example. Suppose fixed costs incurred by comparable (say, A) are Rs. 100 and it has capacity utilization of 50% as against capacity utilization of 25% by assessee. above percentages show 16 IT(TP)A No.1494(B)2010 that assessee has incurred full fixed costs with 25% of utilization of its capacity, as against incurring full fixed costs with 50% of its capacity utilization. This divulges that assessee has incurred relatively more fixed costs and has incurred lower costs. In order to make effective comparison, there arises need to obliterate effect of this difference in capacity utilizations. It can be done by proportionately scaling up fixed costs incurred by so as to make it fully comparable with assessee. This we can do by increasing fixed costs of to Rs. 200 (Rs.100 into 50/25) as against actually incurred fixed costs by it at Rs.100. When we compute operating profit of by substituting fixed costs at Rs.200 with actually incurred at Rs.100, it would mean that fixed costs incurred by assessee and are at same capacity utilization. There can be converse situation as well. Suppose fixed costs incurred by comparable (say, B) are Rs. 100 and it has capacity utilization of 25% as against capacity utilization of 50% by assessee. above percentages show that assessee has incurred full fixed costs at 50% of utilization of its capacity, as against B incurring full fixed costs at 25% of capacity utilization. This deciphers that 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 fixed costs incurred by B so as to make it fully comparable. This we can do by reducing fixed costs of B to Rs. 50 (Rs.100 into 25/50) as 17 IT(TP)A No.1494(B)2010 against actually incurred fixed cost by it at Rs.100. When we compute operating profit of B by substituting fixed costs at Rs.50 with actually incurred at Rs.100, it would mean that fixed costs incurred by assessee and B are at same capacity utilization level. From above paras of Tribunal order, it is seen that Tribunal has given detailed guidelines as to how to make or grant capacity utilization adjustment. Hence, we feel it proper that this matter also should go back to file of AO/TPO for granting capacity utilization adjustment as per guidelines given by Tribunal in case of DCIT Vs Class India Pvt.Ltd., (Supra). It is ordered accordingly. In result, appeal stands allowed for statistical purposes in terms indicated above. Order pronounced in open court on date mentioned on caption page. (SUNIL KUMAR YADAV) (A.K. GARODIA) JUDICAL MEMBER ACCOUNTANT MEMBER Place: Bangalore: Dated : 18.10.2016 am Copy to : 1 Appellant 2 Respondent 3 CIT(A)-II Bangalore 4 CIT 5 DR, ITAT, Bangalore. 6 Guard file By order, AR, ITAT, Bangalore 18 IT(TP)A No.1494(B)2010 1. DATE OF DICTATION 2. DATE ON WHICH TYPED DRAFT IS PLACED BEFORE DICTATING MEMBER 3 DATE ON WHICH APPROVED DRAFT COMES TO PS/Sr.PS . 4. DATE ON WHICH ORDER IS PLACED BEFORE DICTATING MEMBER FOR PRONOUNCEMENT 5. DATE ON WHICH ORDER COMES BACK TO PS/Sr.PS .. 6 DATE OF UPLOADING ORDER ON WEBSITE 7 IF NOT UPLOADED, FURNISH REASON FOR DOING SO . 8. DATE ON WHICH FILE GOES TO BENCH CLERK 9. DATE ON WHICH ORDER GOES FOR XEROX & ENDORSEMENT 10. DATE ON WHICH FILE GOES TO HEAD CLERK 11. DATE ON WHICH FILE GOES TO ASSISTANT REGISTRAR FOR SIGNATURE ON ORDER . 12. DATE ON WHICH FILE GOES TO DESPATCH SECTION FOR DESPATCH OF TRIBUNAL ORDER 13. DATE OF DESPATCH OF ORDER . M/s. Molex India Tooling Pvt. Ltd. v. Deputy Commissioner of Income-tax, Circle-12(1), Bangalore