IN INCOME TAX APPELLATE TRIBUNAL D BENCH : CHENNAI BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SHRI G.PAVAN KUMAR, JUDICIAL MEMBER I.T.A.No.855/Mds./2015 Assessment year : 2010-11 M/s.KOB Medical Textiles Pvt Vs. DCIT, Ltd., Circle-2, Tirupur. S.F.No.29-30,Perumpali, Semmipalayam village, Trichy road, Palladam 641 662. [PAN AABCK2679R ] (Appellant) (Respondent) Appellant by : Mr.Kapil Hirani,Advocate Mr. Darpan Kirpalani,Advocate Respondent by : Date of Hearing : 11-01-2017 Date of Pronouncement : 09-03-2017 ORDER PER CHANDRA POOJARI, ACCOUNTANT MEMBER This appeal of assessee are directed against Assessment order dated 30.01.2015 for A.Y 2010-11, consequent to directions :- 2 -: ITA No.855 /Mds./2015 of Dispute Resolution Panel (DRP), Chennai, dated 29.12.2014 u/s. 143(3) r.w.s.92CA(3) of Act. 2. brief facts of case are that assessee is 100% subsidiary of Karl Otto Braun KG. Germany and engaged in business of manufacture of Elastic Badages for Fixation, support, compression & Crape and cotton Bandages. assessee is 100% Export Oriented Unit (EOU) as approved by Ministry of Commerce and Industry. assessee filed its return of income for assessment year 2010-11 on 13.10.2010 declaring income of `11,47,340/- after claiming deduction u/s.10B of Act to extent of `1,20,28,476/-. As Company was having international transactions, reference was made to TPO u/s.92CA of Act. Based on order of TPO, draft assessment order was passed which was confirmed by DRP vide order dated 29.12.2014 making additions as under:- Sl.No. Particulars Amount (INR) 1 ALP upward adjustment to international 4,01,18,062/- transactions 2 Disallowance of claim of deduction u/s.10B 1,20,28,476/- Total 5,21,46,538/- Consequently, AO passed assessment order on 30.01.2015. Against this assessee is in appeal before us. :- 3 -: ITA No.855 /Mds./2015 3. first ground for our consideration is with regard to sustaining addition of `4,01,18,602/- towards upward adjustment in ALP of Transfer Pricing adjustmets with following grounds:- 2. Transfer pricing adjustments 2.1 learned DRP, AO and TPO (collectively referred to as lower authorities ) have erred in law and facts by making adjustment to transfer price of Appellant by INR 40,118,602. 2.2 learned lower authorities failed to appreciate fact that AY 2010- 11 was abnormal year of operations for Appellant: 2.2.1 Appellant expanded its manufacturing facility by expanding its weaving production line and addition of knitting division; and 2.2.2 Such expansion resulted in certain capacity cost which could not be absorbed due to underutilization of capacity. 2.3 learned lower authorities have erred in law and facts by considering only single year financial data instead of multiple year financial data considering abnormal year of operations of Appellant. 2.4 learned lower authorities have erred in law and facts by not granting: 2.4.1 Economic and commercial adjustments without taking cognizance of Appellant s limited risk nature vis- -vis entrepreneurial risks borne by comparable companies; and 2.4.2 Working capital adjustment for difference in level of investments in working capital between assessee and comparable companies. 2.5 learned lower authorities have erred in law and facts by not taking cognizance of submissions made by Appellant mapping significant :- 4 -: ITA No.855 /Mds./2015 market risk borne by comparable companies and matured stage of operations as compared to Appellant s first year of knitting division operations. 2.6 learned authorities have erred in law and facts by re-computing arm s length price without rejecting Transfer Pricing documentation maintained by Appellant in good faith. In this regard, order of learned lower authorities to extent prejudicial to Appellant is bad in law and liable to be quashed. 4. Before us, ld.A.R submitted that assessee undertakes contract manufacturing for its Group Companies and is compensated for its activities on cost plus model based on intragroup Contract manufacturing agreement. It is submitted that assessee applying Transactional Net Margin Method (TNMM) as Most Appropriate Method (MAM) and return on total operating cost (OP/TC) as Profit Level Indicator (PLI) computed its margin at 1.92%. Appellant in its TP analysis selected 4 comparables, whose arithmetic mean of margins came to 10.24% which after risk adjustment came to 2.59% and thus as per proviso to section 92C(2) international transactions of assessee were considered to be at Arm s Length by assessee. ld.A.R challenged the upward adjustment made by TPO and sustained by DRP on primarily 2 counts: i. Adjustnent towards Risk Profile of Appellant compared with that of Comparable Companies and :- 5 -: ITA No.855 /Mds./2015 ii. Adjustment towards Abnormal Expenses incurred by Appellant during year. According to ld.A.R, Adjustment towards Risk Profile undertaken by Appellant is different than that of comparable companies and as such margins of comparables warrant adjustments. assessee is contract manufacturer and comparables are entrepreneur companies. Appellant does not bear any market risk, credit risk, R&D risk and foreign exchange risk. risks borne by entrepreneur companies are significantly higher when compared to contract manufacturer. 4.1 Further, ld.A.R drew our attention to assessee s letter dated 23.12.2013 filed before TPO given details of risk adjustment (Copy at pages 246-255 of Paper Book). average risk adjusted margin of comparable companies comes to 2.59% which when compared to margin of Appellant of 1.92% and after giving benefit of proviso to section 92C(2) of 5% is at arms length and as such no adjustment to ALP is warranted. ld.A.R further vide submission dt. 9.1.2014 (copy at pages 266-289 of Paper Book) and vide submission dt. 17.1.2014 (copy at pages 290-308 of Paper Book) in response to Show Cause Notices issued by TPO explained in detail methodology of calculating Risk Adjustment as claimed by Appellant. ld.A.R pleaded that Ld. TPO/DRP :- 6 -: ITA No.855 /Mds./2015 ignoring submissions and contentions of Appellant and merely on conjectures and surmises proceeded to dismiss claim of Appellant for risk adjustment. extent of risk being integral part in determining extent of margin earned, adjustment towards risk becomes imperative. assessee further more having given detailed working of same, claim of assessee towards risk adjustment deserves to be allowed in interest of natural justice. 5. On other hand, ld.D.R submitted that though assessee mentioned Risk Profile in TP documentation, it is not possible to ascertain exact risk profile of comparables to see that they were exposed to different levels of risk. According to ld.D.R, when assessee made claim of risk adjustments, initial onus is on assessee to file requisite information pertaining to that claim. However, assessee failed to discharge its initial onus. In absence of relevant information to compute reliable and accurate adjustments, it cannot be made to profit margin of comparables. assessee has not been able to make case for itself on preliminary concept of reasonability and hence question for any adjustment cannot be made. Rule 10C(2)(e) of Income Tax Rules, 1962 provides extent to which reliable and accurate adjustments can be made to account for differences, if any, :- 7 -: ITA No.855 /Mds./2015 between international transaction and comparable uncontrolled transaction or between enterprises entering into such transactions. He has relied on order of Tribunal in case of ADP (P) Ltd., Vs. DCIT reported in (2011) 57 ITR (Hyd.)(Trib) 310 and in case of DCIT Vs. Deloitte Consulting (India) Pvt. Ltd., in (2011) 61 DTR (Hy.)(Trib) 101. 6. We have heard both parties and perused material on record. As pointed out by ld.D.R, there is no thumb rule for risk adjustments in each and every cases, whenever assessee claimed any risk adjustment in accordance with Rule 10C(2)(e). While arriving ALP, assessee has to identify and quantify level of risk involved between assessee and comparables while undertaking for analyses in transfer pricing documents. risk adjustments could be given only to company to company basis considering levelof risk involved between assessee and comparable companies. It is primary duty of assessee to provide requisite information pertained to claim. Since assessee did not discharge its initial onus and in absence of information to compute reliable accurate risk adjustments, it is not possible to grant risk adjustments claimed by assessee. However, considering high degree of risk involved with comparables, we are inclined to grant risk :- 8 -: ITA No.855 /Mds./2015 adjustments at 2% on adhoc basis. Accordingly, this ground is partly allowed. 7. next issue is with regard to Adjustment towards Abnormal Expenses. 7.1 Before us, ld.A.R submitted that assessee is contract Manufacturer. Vide contract manufacturer agreement; assessee is entitled to compensation of cost plus 9.5% which was reduced to 7% w.e.f 1.1.2010. Cost includes cost of materials, manufacturing overheads and store-cost and Administration cost and other essential costs except Corporate taxes but including Fringe Benefit Tax. Further, ld.A.R submitted that A.E is supposed to issue to appellant within 60 days prior to end of each calendar year forecast of contract manufacture containing details and estimates of contract manufacture required to next calendar year. assessee in turn submits operating plan giving estimates of costs to it s A.E based on which Selling Price is fixed and Selling Price remains constant throughout year. Considering same, assessee could not predict abnormal costs it incurred during year which could be factored in Selling Price which affected its margins. According to ld.A.R, such abnormal costs deserve to be excluded while determining ALP adjustments. assessee has incurred following abnormal costs :- 9 -: ITA No.855 /Mds./2015 a. Abnormal Wastage of materials amounting to Rs. 1,43,17,081/- and b. Depreciation 7.2 ld.A.R submitted following points for our consideration with regard to Abnormal Material Wastage Rs. 1,43,17,081/-. a. assessee expanded its manufacturing facility by expanding its weaving production line and also has started knitting division during year under appeal. material cost during year under appeal was significantly high due to first year of knitting operations. Due to learning curve of new operators, there is abnormal wastage of materials to tune of Rs. 1,43,17,081/- (Rs. 1.43 Crores approx) b. assessee has considered F.Y 2008-09 as base year as business operations in F.Y 2008-09 were conducted in normal business conditions wherein material cost was 53.83% of Sales. Considering same ratio for current year, abnormal material wastage comes to Rs. 1,43,17,081/- (Detailed working at page 12 of TPO order). c. abnormal wastages being extraordinary and nonrecurring items deserve to be excluded while determining margins earned in interest of natural justice. :- 10 -: ITA No.855 /Mds./2015 7.3 ld.A.R submitted following points for our consideration with regard to Depreciation Rs. 1,56,12,909/- (99,94,929/- + 56,17,980/-) a. assessee has during year revised estimated economic life of its fixed assets based on technical study resulting in excess depreciation charge to Profit & Loss Account. Reference to Point No. 2 of Schedule 18 of Annual Report at page 150 of Paper Book wherein it has been disclosed as under: During year, company has revised estimated economic useful life of its fixed assets based on technical study. As result of this change, depreciation charge for year has increased by Rs. 99,94,929/- with consequential impact on profit for year. b. appellant has further calculated amount of Rs. 56, 17,980/- as excess depreciation charged during year on account of expansion of weaving production line. appellant has made investment in Fixed Assets amounting to Rs. 21,94,56,363/- (Rs. 22 Crores approx) (Details at page 144 of Paper Book) which has resulted in excess depreciation for year. c. appellant has taken F.Y 2008-09 as base year as business operations in F.Y 2008-09 were conducted in normal business conditions wherein depreciation was 3.78% of Sales. Considering same ratio for current year, abnormal depreciation comes to 1,56,12,909/- out of which Rs. 99,94,929/- is on account of revision of estimated useful life of :- 11 -: ITA No.855 /Mds./2015 assets as per point (a) supra and balance amount of Rs. 56,17,980/- has thus been attributed to abnormal depreciation attributable to expansion. (Detailed working at page 13 of TPO order). d. excess depreciation being abnormal costs deserve to be excluded while determining margins earned in interest of natural justice. i. Appellants operating margins for various years are as under: a. A.Y 2007-08 11.00% b. A.Y 2008-09 10.03% c. A.Y 2009-10 14.60% d. A.Y 2010-11 1.92% e. A.Y 2011-12 8.39% f. A.Y 2012-13 7.56% 7.4 According to ld.A.R, above details support contention of appellant that there were significant abnormal costs incurred by appellant during year under appeal i.e AY 2010-11 resulting in aL3normally lower profits which needs to be given due adjustment while determining ALP in interest of natural justice. 7.5 According to ld.A.R, operating margin of assessee after excluding abnormal costs specified above comes to 14.10% which after considering adjustment of +5% as per proviso to section 92C(2) makes margin of Appellant when compared to margins of comparables at 10.24% making any adjustment to ALP unwarranted and liable to be deleted. :- 12 -: ITA No.855 /Mds./2015 8. On other hand, ld.D.R submitted that before commencement of each calendar year on basis of forecast given by AE, assessee has to submit its estimate of budgeted cost. claim of abnormal material cost due to learning curve in respect of newly started knitting division should have been anticipated by assessee and should have been provided for suitably. Besides, change in accounting policy, of providing for depreciation on estimating useful life of assets is another factor assessee should have taken note of. Both above mentioned expenditures satisfy definition of cost as per contract manufacturing agreement entered into. Besides, agreement also provides for factoring in modifications during relevant previous year. Therefore, claim of assessee does not deserve merit. According to ld.D.R, appreciable drop in profit margin despite fact that mark up has been revised to 5% to 93% and thereafter slashed down to 7% was not taken into account by assessee while explaining dismal performance during year. reason why assessee has agreed to work for lower margin of 7%, reduction of 2.5% for period of three months during relevant previous year from first of January 2010, despite claim of extraordinary expenditure is something only assessee could explain. Since assessee as contract manufacturer is operating on cost plus model and agreement provides for reckoning all expenses other than finance cost and taxes, claim to exclude above from operating expenditure deserves no consideration. :- 13 -: ITA No.855 /Mds./2015 9. We have heard both parties and perused material on record. assessee is contract-manufacturer and having mark-up raised from 5% to 9.5% on goods procured by it, later it was revised to 7%, so that wastage suffered by assessee taken care of by mark-up prices and manufactured goods. Once price was marked up, there cannot be any loss to assessee and entire wastage is taken care by marked up price of sale price. Hence, we do not find any merit in plea of assessee with regard to claim of abnormal wastage. 10. Next issue is with regard to abnormal depreciation. As discussed in earlier, assessee s pricing pattern is marking up of 7% on cost of goods manufactured. Being so, increase in depreciation cost has also taken care of by mark up of sales price. Accordingly, assessee cannot seek any further adjustments towards additional depreciation cost. This ground of appeal by assessee is also rejected. 11. next issue is with regard to reject claim of deduction u/s.10B of Act. :- 14 -: ITA No.855 /Mds./2015 12. Before us, ld.A.R has advanced following reasons in support of claim of deduction u/s.10B of Act by assessee. a) assessee filed its return of income claiming deduction U/s. 10B of ` 1,20,28,476/-. assessee has been regularly getting benefit of deduction U/s. 10B for past many years. assessee had commenced production in A.Y 2001-02 and as such according to terms of section 10B assessee was entitled to claim deduction till 10 years starting from A.Y 2001-02 and ending in A.Y 2010-11 i.e year under appeal. b) During A.Y 2000-01, assessee had undertaken trial runs to test functioning of machinery and quality of products to be manufactured. Assessee had submitted date of trial run being 27th March 2000 in performance report which was filed with Madras Export Processing Zone (MEPZ). date as mentioned in performance report was erroneously considered in Form 56G as well which was not correct as actual production had not commenced as on 27.3.2000. Assessee has not claimed any deduction U/s 10-B for A.Y 2000-01. Assessee, in order to commence its manufacturing activities was :- 15 -: ITA No.855 /Mds./2015 granted following statutory approvals / registrations from statutory authorities 1. Approval under Factories Act, 1948 on 31st March 2000 2. Approval of Divisional Fire Officer, Coimbatore on 4 April 2000 3. Approval of Factory inspector for factory building 10th April 2000 4. Approval of Deputy Director, Town and Country Planning on 29 May 2000. 5. Health and Safety Clearance received on 27 March 2000. assessee had commenced production after receipt of above approvals without which assessee was not authorized to commence production. Though trial run is permitted before aforesaid approvals are obtained, commercial production can only commence after obtaining all above mandatory approvals. c) Assessing Officer (AO) simply relying on date of commencement of manufacture as erroneously mentioned in Form 56G as 27.3.2000 which was date of conduct of trial run as mentioned in performance report filed with MEPZ considered A.Y 2000-01 as initial year for claiming deduction U/s 10B and accordingly held 10th consecutive year of deduction as A.Y 2009-10 thus denying Appellant benefit of deduction U/s 10B for A.Y2010-11. That assessee did not :- 16 -: ITA No.855 /Mds./2015 commence production in A.Y 2000-01 is further substantiated from fact that Appellant in A.Y 2001-02 procured raw material of 28 tons for carrying out commercial production whereas in A.Y 2000-0 1 it had procured only 0.08 ton which was used for trial run. d) ld.A.R places reliance on CIT Vs. Himalayan Magnesite Ltd. (2005) 276 ITR 56 (Allahabad) wherein Hon ble High Court while deciding allowability of deduction under erstwhile section 80I held that deduction has to be allowed held that assessee having undertaken only trial production in relevant previous year and regular production having started in subsequent year, assessee was not entitled to deduction U/s 80J. Going by same analogy deduction U/s 10-B has to be allowed only in year of actual commercial production and not in year of trial production. e) ld.A.R further places reliance on Dy CIT Vs. Bhansali Trading Co. ITA No. 784/JP/2014 wherein Hon ble ITAT has while deciding allowability of deduction U/s 10B held as under:- -Deduction under section 10B--100 Per cent export oriented undertakings No positive income accrued to assessee-- Commencement of period of ten consecutive years -- Period :- 17 -: ITA No.855 /Mds./2015 often consecutive years for claiming of deduction under section lOB commenced from assessment year in which positive income first accrued to assessee, i.e., assessment year 2002-03 and not from assessment year 2001-02 in which it started manufacturing activity. AO was not, therefore, justified in disallowing deduction for assessment year 2011-12 as same for there of eligibility period starting from assessment year 2002-03. --Assessee registered as 100 percent Export Oriented Undertaking (EOU) commenced manufacturing and production on 12-3-2001 claimed deduction under section lOB for assessment year 2011-12. AO disallowed same on ground that as assessee had commenced manufacturing activity in financial year 2000-0 1 which was evident from claim of depreciation for assessment year 2001-02, eligibility period of ten consecutive years was, therefore, completed in assessment year 2010-11. Assessee contended that though registration as EOU was effective earlier, deduction under section lOB for first time was claimed in assessment year 2002-03 and ten consecutive years, therefore, completed in assessment year 2011-12. Held: If assessee was having positive income, then only there was occasion to claim deduction under section 108. As positive income accrued to it in assessment year 2002-03 and from then onwards it claimed deduction for period of ten consecutive years ending in assessment year 2011- 12. AO was not, therefore, justified in making disallowance for assessment year 2011-12. f) According to ld.A.R, above case covers case of Appellant in toto in as much as in A.Y 2000-01, appellant did not have any positive income and as such there was no occasion to claim deduction :- 18 -: ITA No.855 /Mds./2015 U/s 10B. assesseethus started claiming deduction from A.Y 2001- 02 onwards which corresponded to period of commencement of commercial production and accordingly A.Y 2001-02 ought to be considered as initial year of deduction and accordingly 10th consecutive year would be A.Y 2010-11 making appellant entitled to deduction U/s 10B for year under appeal. 13. On other hand, ld.D.R submitted that deduction u/s.10B is available for period of 10 successive assessment years starting from year in which undertaking begins to manufacture things or article etc. Furhter, ld.D.R submitted that assessee started activity of manufacturing goods. However, production of finished goods did not come into existence as on 31.03.2000. raw material and stores consumed in manufacturing activity have remained in form of work in progress as on 31.03.2000. There is no dispute in this regard. As per Form No.56 G, date of commencement of production is 27.03.2000 itself. Ld.D.R submitted that assessment year 2010-11 is 11th year and assessee is not eligible for deduction u/s.10B of Act. 14. We have heard both parties and perused material on record. main plea of assessee is that present assessment :- 19 -: ITA No.855 /Mds./2015 year 2010-11 is 10th year of claim of deduction u/s.10B of Act and filed copy of return for assessment year 2000-01 stating that there was no claim of deduction u/s.10B of Act. He has also relied on judgement of Jaipur Bench of Tribunal in case of CIT Vs. Bhansali Trading Company in ITA No.784/JP/2014 vide order dated 14th July 2016 for assessment year 2011-12 wherein held that if assessee is having positive income, then only there was occasion to claim deduction u/s.10B of Act as positive income accrued to it in assessment year 2002-03 and then onwards it claimed deduction u/s.10B of Act for period of ten consecutive years ending in assessment year 2011-12. AO is not therefore justified in making disallowance for assessment year 2011-12. 14.1 In present case of assessee also, there was business loss in assessment year 2000-01 and assessee has not claimed deduction u/s.10B of Act and made note in statement of income that company is claiming exemption u/s.10B of Act from this assessment year onwards. There was no claim of deduction u/s.10B and also Revenue is not allowed any claim u/s.10B of Act in relevant to assessment year 2000-01, as such it is to be noted that assessment year 2000-01 cannot be considered as first year of claim of deduction u/s.10B of Act. From assessment year :- 20 -: ITA No.855 /Mds./2015 2001-02, deduction u/s.10B of Act was to construed as first year of claim of deduction u/s.10B of Act. Accordingly, it is to be allowed for ten consecutive years commencing from assessment year 2001-02 ending on assessment year 2010-11. Accordingly, we direct AO go grant deduction u/s.10B of Act. This ground of assessee is allowed. 15. In result, appeal of assessee is partly allowed. Order pronounced on 09th March, 2017, at Chennai. Sd/- Sd/- (G.PAVAN KUMAR) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER Chennai Dated: 09th March, 2017. K S Sundaram Copy to: 1. Appellant 3. CIT(A) 5. DR 2. Respondent 4. CIT 6. GF KOB Medical Textiles Pvt Ltd. v. DCIT, Circle-2, Tirupur