DCIT RG 8(2), MUMBAI v. PETRO ARALDITE P.LTD, MUMBAI

ITA 3782/MUM/2011 | 2005-2006
Pronouncement Date: 24-07-2013 | Result: Partly Allowed

Appeal Details

RSA Number 378219914 RSA 2011
Assessee PAN AAACP5685K
Bench Mumbai
Appeal Number ITA 3782/MUM/2011
Duration Of Justice 2 year(s) 2 month(s) 15 day(s)
Appellant DCIT RG 8(2), MUMBAI
Respondent PETRO ARALDITE P.LTD, MUMBAI
Appeal Type Income Tax Appeal
Pronouncement Date 24-07-2013
Appeal Filed By Department
Order Result Partly Allowed
Bench Allotted K
Tribunal Order Date 24-07-2012
Date Of Final Hearing 18-06-2013
Next Hearing Date 18-06-2013
Assessment Year 2005-2006
Appeal Filed On 09-05-2011
Judgment Text
IN THE INCOME TAX APPELLATE TRIBUNAL K BENCH MUMBAI .. !'# $ $ $ $ %$ $ & !'# !' BEFORE SHRI P.M. JAGTAP AM AND SHRI VIJAY PAL RAO JM !./ I.T.A. NO. 3782/MUM/2011 ( &) * $+* &) * $+* &) * $+* &) * $+* / / / / ASSESSMENT YEAR : 2005-06) DY. COMMISSIONER OF INCOME TAX RG. 8(2) ROOM NO. 216-A AAYAKAR BHAVAN M.K. ROAD MUMBAI. ) ) ) ) / VS. M/S PETRO ARALDITE P. LTD. 782-882 SOLITAIRE CORPORATE PARK 167 GURU HARIGOVINDJI MARG ANDHERI GHATKOPAR ROAD ANDHERI (E) MUMBAI 400 093. # !./ PAN : AAACP5685K ( - / // / APPELLANT ) .. ( ./ - / RESPONDENT ) - 0 1 ! / APPELLANT BY : SHRI AJEET KUMAR JAIN SHRI A.C. TEJPAL ./ - 0 1 ! / RESPONDENT BY : SHRI R.C. JAIN !)$ 0 / // / DATE OF HEARING : 18-6-13 23+ 0 / DATE OF PRONOUNCEMENT : 24-07-13 '4 / O R D E R PER P.M. JAGTAP A.M . .. !'# : THIS APPEAL IS PREFERRED BY THE REVENUE AGAINST THE ORDER OF LD. CIT(A) 15 MUMBAI DATED 21-2-2011. ITA NO. 3782/MUM/2011 2 2. IN GROUND NO. 1 2 & 3 THE REVENUE HAS CHALLEN GED THE ACTION OF THE LD. CIT(A) IN DELETING THE ADDITION OF RS. 5 79 00 000/ - MADE BY THE A.O. ON ACCOUNT OF TRANSFER PRICING ADJUSTMENT. 3. THE ASSESSEE IN THE PRESENT CASE IS A COMPANY WH ICH IS ENGAGED IN THE BUSINESS OF MANUFACTURING AND DEALING IN BASIC LIQU ID AND SOLID RESINS AS WELL AS FORMULATIONS. IT IS A JOINT VENTURE COMPANY BETW EEN CIBA INDIA LIMITED AND TAMIL NADU PETROPRODUCTS LTD. THE RETURN OF INCOME FOR THE YEAR UNDER CONSIDERATION WAS FILED BY THE ASSESSEE COMPANY ON 28-10-2005 DECLARING TOTAL INCOME AT NIL AFTER SETTING OFF ITS ENTIRE PROFIT FOR THE YEAR UNDER CONSIDERATION AGAINST THE BROUGHT FORWARD LOSSES OF THE EARLIER YEARS. DURING THE YEAR UNDER CONSIDERATION THE ASSESSEE HAD ENTE RED INTO THE FOLLOWING INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATED ENTE RPRISES (AES):- (1) EXPORT OF FINISHED GOODS TO AES IN VARIOUS COUNTRIES :RS.28 60 843/- (2) IMPORT OF RAW MATERIALS FROM AES IN VARIOUS COUNTRIES :RS.16 15 91 463/- (3) MANAGEMENT CHARGES PAID TO AES IN VARIOUS COUNTRIES :RS.2 91 20 790/- IN THE TP STUDY REPORT TNMM WAS ADOPTED BY THE ASS ESSEE AS THE MOST APPROPRIATE METHOD TO BENCHMARK THE ABOVE TRANSACTI ONS WITH ITS AES AND OPERATING PROFIT TO SALES WAS TAKEN AS PLI. ALL TH E TRANSACTIONS WITH THE AES WERE AGGREGATED FOR BENCHMARKING AS PER THE SAID ME THOD AND THE FOLLOWING TWO ENTITIES WERE IDENTIFIED AS COMPARABLES:- 1. RESINS & PLASTICS LTD. 2. SANMAR SPECIALITY CHEMICALS LTD. 4. THE AVERAGE PLI I.E. OP TO SALES OF THE ABOVE TW O COMPARABLES WAS WORKED OUT AT 8.54% AND THE SAME BEING LESS THAN 12 .55% OF THE ASSESSEE IT ITA NO. 3782/MUM/2011 3 WAS CLAIMED THAT ALL THE INTERNATIONAL TRANSACTIONS WITH AES WERE AT ARMS LENGTH. 5. WHEN REFERENCE WAS MADE BY THE A.O. TO THE TPO F OR DETERMINING THE ALP OF THE INTERNATIONAL TRANSACTIONS OF THE ASSESS EE COMPANY WITH ITS AES THE TPO FOUND THAT THE OP TO SALES AT 12.55% WAS WO RKED OUT BY THE ASSESSEE WITHOUT DEDUCTING DEPRECIATION AMOUNTING TO RS. 6.1 5 CRORES FROM THE OPERATING MARGIN. SINCE THE DEPRECIATION WAS INEXT RICABLY LINKED TO THE PRODUCTION PROCESS THE TPO INCLUDED THE DEPRECIATI ON TO WORK OUT THE TOTAL OPERATING COST AT RS. 144.13 CRORES AND AFTER DEDUC TING THE SAME FROM THE TOTAL SALES OF RS. 157.80 CRORES HE WORKED OUT THE OP OF THE ASSESSEE (BEFORE INTEREST AND TAX) AT RS. 13.67 CRORES GIVING OP TO SALES AT 8.63%. THE TPO ALSO CARRIED OUT HIS OWN SEARCH USING THE RELEVANT CRITERIA WHICH YIELDED THREE MORE COMPARABLES IN ADDITION TO TWO COMPARABLES SEL ECTED BY THE ASSESSEE MAKING TOTAL COMPARABLES TO FIVE. ONE COMPARABLE N AMELY SANMAR SPECIALITY CHEMICALS LTD. HOWEVER WAS OMITTED BY THE TPO FRO M THE SET OF COMPARABLES SINCE THE FINANCIAL DATA OF THE SAID COMPANY FOR TH E FINANCIAL YEAR 2004-05 WAS NOT AVAILABLE AS AGREED EVEN BY THE ASSESSEE. ACCORDINGLY THE FINAL COMPARABILITY ANALYSIS WAS CARRIED OUT BY THE TPO B Y TAKING THE REMAINING FOUR COMPARABLES AND ADOPTING THE OP TO TOTAL COST AS PLI AS UNDER:- NAME OF THE COMPARABLE OPERATING PROFIT MARGIN USIN G PLL OPERATING PROFIT TO TC% RESINS & PLASTICS LTD 10.90% 3M INDIA LTD 17.30% ELANTAS BECK INDIA LTD 17.51% DOJODWALL PAPER CHEMICALS LTD 8.28% AVERAGE OP/TC OF COMPARABLES 13.50% OP ON THE TC IN THE CASE OF THE ASSESSEE 9.48% ITA NO. 3782/MUM/2011 4 AS THE OP TO TC OF THE ASSESSEE AT 9.48% WAS LOWER THAN THE AVERAGE OF OP TO TC OF THE FOUR COMPARABLES WORKED OUT AT 13.50% TH E ASSESSEE WAS CALLED UPON BY THE TPO TO EXPLAIN AS TO WHY THE ALP OF THE INTERNATIONAL TRANSACTIONS WITH ITS AES SHOULD NOT BE DETERMINED BY APPLYING OP TO TC OF 13.50% AND TP ADJUSTMENT SHOULD NOT BE MADE ACCORDI NGLY. THE ASSESSEE HOWEVER DID NOT OFFER ANY EXPLANATION IN THE MATTE R AND KEEPING IN VIEW THIS NON-COMPLIANCE OF THE ASSESSEE THE TPO PROCEEDED T O WORK OUT THE TP ADJUSTMENT AT RS. 5.79 CRORES AS UNDER:- AMT. IN RS. A. SALES 157.80 CR. B. TOTAL COST (INCLUDING DEPRECIATION) 144.13 CR. C. OPERATING PROFIT (BEFORE INTEREST AND TAX) 13.67 CR. D. OP/TC% IN THE CASE OF THE ASSESSEE 9.48% E. ARITHMETICAL MEAN OF THE OP/TC% OF THE COMPARABLES 13.50% F. OP/TC AS PER ARMS LENGTH MARGIN I.E. 13.50% 19.46 CR. G. DIFFERENCE 5.79 CR. THE ADDITION OF RS. 5.79 CRORES ACCORDINGLY WAS MAD E BY THE A.O. TO THE TOTAL INCOME OF THE ASSESSEE ON ACCOUNT OF TRANSFER PRICI NG ADJUSTMENT IN THE ASSESSMENT COMPLETED U/S 143(3) OF THE ACT VIDE AN ORDER DATED 12-12-2008. 6. AGAINST THE ORDER PASSED BY THE A.O. U/S 143(3) OF THE ACT APPEAL WAS PREFERRED BY THE ASSESSEE BEFORE THE LD. CIT(A) DIS PUTING THE ADDITION MADE BY THE A.O. ON ACCOUNT OF TRANSFER PRICING ADJUSTMENT. BEFORE THE LD. CIT(A) IT WAS SUBMITTED ON BEHALF OF THE ASSESSEE THAT THE TP O COMPLETELY FAILED TO APPRECIATE THE DIFFERENCE IN THE CAPACITY UTILIZATI ON BETWEEN THE ASSESSEE COMPANY AND THE COMPARABLE COMPANIES. IT WAS SUBMI TTED THAT THE TPO GROSSLY FAILED IN NOT CONSIDERING THE ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION AND IGNORED THE EFFECT OF UNDER UTILIZA TION OF PLANT BY THE ASSESSEE ITA NO. 3782/MUM/2011 5 WHICH RESULTED IN IDLE CAPACITY. IT WAS POINTED OUT THAT THE CAPACITY UTILIZATION OF THE ASSESSEE WAS ONLY 65% AS AGAINST MORE THAN 8 0% CAPACITY UTILIZATION IN THE CASES OF COMPARABLES. 7. THE ASSESSEE ALSO OBJECTED TO THE NEW COMPARABL E SELECTED BY THE TPO AND MADE THE FOLLOWING SUBMISSION TO SHOW THAT THE COMPANIES SELECTED BY THE TPO WERE ACTUALLY NOT COMPARABLE WITH THE ASSES SEE COMPANY:- 3 M INDIA LIMITED THE COMPANY HAS SIGNIFICANT RELATED PARTY TRANSACTI ON AND SHOULD BE REJECTED. RELATE PARTY TRANSACTIONS ACCOUNT FOR 36% OF THE TO TAL REVENUE TO WHICH THE PRICES AT WHICH TRANSACTIONS ARE ENTERED INTO MAY B E INFLUENCE. HENCE THIS COMPANY SHOULD BE REJECTED AND SHOULD NOT BE TAKEN AS A COMPARABLE TO THE APPELLANT. ELANTAS BECK INDIA LIMITED THE COMPANY HAS DIVERSE OPERATIONS. THE COMPANYS O PERATION HAVE BEEN CLASSIFIED INTO TWO PRIMARY SEGMENTS ELECTRICAL I NSULATIONS AND ENGINEERING & ELECTRONIC RESINS AND MATERIALS AS PER NOTES TO ACCOUNTS OF MARCH 2005. THE COMPANY ALSO HAS RELATED PARTY TRAN SACTION. HENCE THIS COMPANY SHOULD BE REJECTED AND SHOULD NOT BE TAKEN AS A COMPARABLE TO THE APPELLANT. DUJODWALLA PAPER CHEMICALS LIMITED THE COMPANY IS ENGAGED IN TRADING ON FARM INPUTS. H ENCE THIS COMPANY SHOULD BE REJECTED AND SHOULD NOT BE TAKEN AS A COMPARABLE TO THE APPELLANT. 8. IT WAS ALSO BROUGHT TO THE NOTICE OF THE LD. CIT (A) ON BEHALF OF THE ASSESSEE THAT ITS SALES TO NON-ASSOCIATED ENTERPRIS ES WAS 82% OF THE TOTAL SALES AND THE A.O. COMPUTED THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTIONS OF SALES TO AES BY ADDING THE DIFFEREN CE IN THE PROFIT MARGIN IN RESPECT OF THE ENTIRE SALES. RELYING ON THE VARIOU S DECISIONS OF THE TRIBUNAL IT WAS CONTENDED ON BEHALF OF THE ASSESSEE THAT THE DI FFERENCE IN THE PROFIT MARGIN AS WORKED OUT BY THE TPO SHOULD BE APPLIED O NLY TO THE INTERNATIONAL TRANSACTIONS WITH AES TO WORK OUT THE TRANSFER PRIC ING ADJUSTMENT. IT WAS CONTENDED THAT IF THE SAME IS DONE BY APPLYING THE AVERAGE MARGIN OF COMPARABLES OF 13.50% TAKEN BY THE TPO TO THE TRANS ACTION VALUE WITH AES ITA NO. 3782/MUM/2011 6 THE ALP WOULD BE WITHIN THE PERMISSIBLE RANGE OF +/ - 5%. THIS STAND WAS SUBSTANTIATED BY THE ASSESSEE BY FURNISHING THE FOL LOWING WORKING :- PARTICULARS TRANSACTION VALUE ALP REVENUE FROM EXPORT OF FINISHED GOODS 28.60 29.65 LESS: EXPENDITURE 26.12 26.12 EBIT 2.48 3.53 EBIT ON COSTS (AS SUGGESTED BY THE TPO) 9.48% 13.50% ARMS LENGTH PRICE OF SERVICES 29.65 APPLICATION OF THE RANGE ALP*0.95 28.17 APPLICATION OF THE RANGE ALP*1.05 NA TRANSACTION VALUE 28.60 9. AFTER CONSIDERING THE SUBMISSIONS MADE ON BEHALF OF THE ASSESSEE THE LD. CIT(A) IDENTIFIED THREE ISSUES ARISING FROM THE APPEAL OF THE ASSESSEE FOR HIS CONSIDERATION AS UNDER:- 1. CLAIM OF CAPACITY UTILIZATION ADJUSTMENT 2. SELECTION OF COMPARABLES 3. WHETHER PLI HAS TO BE APPLIED ON A WHOLE ENTITY BAS IS OR AE SEGMENTS ONLY. AS REGARDS THE FIRST ISSUE RELATING TO CAPACITY UT ILIZATION ADJUSTMENT THE LD. CIT(A) OBSERVED THAT THE COST INCURRED BY ANY ENTIT Y ARE OF TWO TYPES ; VARIABLE COST WHICH VARIES DIRECTLY WITH THE PRODUCTION LEVE L AND FIXED COST WHICH REMAINS THE SAME IRRESPECTIVE OF THE PRODUCTION LEV EL. HE HELD THAT SINCE THE VARIABLE COST VARIES DIRECTLY WITH THE PRODUCTION L EVEL ITS RECOVERY REMAINS UNIFORM IRRESPECTIVE OF CAPACITY UTILIZATION WHEREA S THE FIXED COST WHICH REMAINS THE SAME IS UNDER RECOVERED AS A RESULT OF UNDER UTILIZATION OF CAPACITY RESULTING IN LOWER PROFITABILITY. HE HELD THAT THERE THUS ARISES NEED TO PERFORM THE CAPACITY UTILIZATION ADJUSTMENT AND THE SAME CAN BE DONE BY EXCLUDING THE DEPRECIATION WHICH REPRESENTS FIXED C OST FOR THE PURPOSE OF WORKING OUT THE PROFIT MARGIN OF THE ASSESSEE AS WE LL AS COMPARABLES. HE ITA NO. 3782/MUM/2011 7 THEREFORE UPHELD THE STAND OF THE ASSESSEE TO TAKE EBDIT (I.E. EARNING BEFORE DEPRECIATION INTEREST TAX) TO SALES AS OPERATING MA RGIN (PLI) FOR THE COMPARABILITY ANALYSIS. ACCORDING TO HIM THE PROF IT BEFORE DEPRECIATION RULES OUT ANY EFFECT ON THE MARGIN ON ACCOUNT OF THE DIFF ERENCE IN CAPACITY UTILIZATION AND THE ASSESSEE THEREFORE WAS RIGHT IN USING EBDIT AS AN APPROPRIATE PLI. HE NOTED IN THIS REGARD THAT THER E WAS A MATERIAL DIFFERENCE IN THE CAPACITY UTILIZATION OF 65% OF THE ASSESSEE AS AGAINST 83.71% AND 87.13% IN THE CASE OF RASIN PLASTICS LTD AND 3 M IN DIA LIMITED TAKEN AS COMPARABLES. 10. AS REGARDS THE COMPARABLES SELECTED BY THE TPO THE LD. CIT(A) FOUND MERIT IN THE CONTENTION OF THE ASSESSEE THAT ONE OF THE COMPARABLE COMPANIES NAMELY 3M INDIA LIMITED HAVING SIGNIFICANT RELATED PARTY TRANSACTIONS OF 36% SHOULD NOT BE TAKEN AS COMPARABLE. AS REGARDS THE OTHER TWO COMPARABLES NAMELY ELANTAS BOOK INDIA LTD. AND DUJODWALLA PAPER CHEMICALS LTD. HE AGAIN AGREED WITH THE CONTENTION OF THE ASSESSEE TH AT THE SAID TWO COMPARABLES TAKEN BY THE TPO BEING FUNCTIONALLY DIF FERENT SHOULD NOT BE TAKEN AS COMPARABLE. HE THEREFORE HELD THAT NONE OF THE SAID THREE NEW COMPARABLE COMPANIES SELECTED BY THE TPO SHOULD BE CONSIDERED AS COMPARABLES FOR DETERMINING THE ALP OF THE INTERNAT IONAL TRANSACTION OF THE ASSESSEE COMPANY WITH ITS AES. 11. AS REGARDS THE THIRD ISSUE AS TO WHETHER THE PL I IS TO BE APPLIED ON ENTITY BASIS OR AE SEGMENT ONLY THE LD. CIT(A) FOU ND MERIT IN THE CONTENTION RAISED ON BEHALF OF THE ASSESSEE WHICH WAS SUPPORT ED BY THE VARIOUS JUDICIAL PRONOUNCEMENTS THAT THE PLI HAS TO BE APPLIED ON A E TRANSACTIONS ONLY AND NOT ON TOTAL TRANSACTIONS AS DONE BY THE TPO. HE AL SO AGREED WITH THE STAND OF THE ASSESSEE THAT IF IT IS SO DONE THE ALP WORK ED OUT OF THE INTERNATIONAL TRANSACTIONS WITH AE IS FALLING WITHIN THE RANGE OF +/- 5% OF THE ACTUAL TRANSACTION VALUE AND THERE WAS NO CASE FOR MAKING ANY TRANSFER PRICING ITA NO. 3782/MUM/2011 8 ADJUSTMENT. ACCORDINGLY THE LD. CIT(A) DELETED TH E ADDITION OF RS. 5.79 CRORES MADE BY THE A.O. ON ACCOUNT OF TRANSFER PRICING ADJ USTMENT. 12. THE LD. D.R. SUBMITTED THAT AS REGARDS THE ISSU E OF THREE NEW COMPARABLES SELECTED BY THE TPO WHICH HAVE BEEN REJ ECTED BY THE LD. CIT(A) HE IS PLACING RELIANCE ON THE ORDER OF THE TPO IN S UPPORT OF THE REVENUES CASE. HE ALSO FAIRLY AGREED THAT THE ISSUE AS TO W HETHER THE PLI OF COMPARABLES IS TO BE APPLIED ON THE TOTAL TRANSACTI ONS OR ONLY ON THE INTERNATIONAL TRANSACTIONS OF THE ASSESSEE WITH AES IS COVERED IN FAVOUR OF THE ASSESSEE BY THE VARIOUS DECISIONS RELIED UPON BY TH E LD. CIT(A) IN HIS IMPUGNED ORDER AND THERE IS NO CONTRARY DECISION TA KING A VIEW IN FAVOUR OF THE REVENUE ON THIS ISSUE. HE HOWEVER CONTENDED THAT IF ONLY ONE COMPARABLE COMPANY IS FINALLY AVAILABLE FOR THE COM PARABILITY ANALYSIS THE ASSESSEE CANNOT CLAIM THE BENEFIT OF +/- 5% ADJUSTM ENT AS PER PROVISO TO SECTION 92-C(2) OF THE ACT. IN SUPPORT OF THIS CON TENTION HE RELIED ON THE DECISION OF THE TRIBUNAL IN THE CASE OF GENERAL ATL ANTA PVT. LTD. VS. ACIT RENDERED VIDE ORDER DTD. 17-5-13 IN ITA NO. 7638/MU M/2011 AND SUBMITTED THAT THE DECISION OF THE LD. CIT(A) IN GIVING THE B ENEFIT OF +/- 5% ADJUSTMENT WHEN ONLY ONE COMPARABLE WAS FINALLY SELECTED BY HI M IS CONTRARY TO THE SAID DECISION OF THE TRIBUNAL. 13. AS REGARDS THE CAPACITY UTILIZATION ADJUSTMENT THE LD. D.R. CONTENDED THAT SUCH ADJUSTMENT CAN BE ALLOWED ONLY AFTER ASCE RTAINING THE REASON FOR LOW CAPACITY UTILIZATION AND EFFECT THEREOF ON THE PROFITABILITY. HE CONTENDED THAT SUCH ADJUSTMENT MADE BY THE ASSESSEE AND ALLOW ED BY THE LD. CIT(A) BY TAKING PROFIT MARGIN BEFORE DEPRECIATION IS NOT COR RECT BECAUSE DEPRECIATION IS AN INTEGRAL PART OF THE OPERATING COST WHICH CANNOT BE IGNORED OR EXCLUDED WHILE COMPUTING THE OPERATING PROFIT. HE CONTENDED THAT THIS METHOD FOLLOWED BY THE ASSESSEE TO REMOVE THE EFFECT OF CAPACITY UT ILIZATION ON THE PROFIT MARGIN IS A VERY CRUDE METHOD AND THE LD. CIT(A) IS NOT JUSTIFIED IN ACCEPTING ITA NO. 3782/MUM/2011 9 THE SAME. AS REGARDS THE DECISION OF THE TRIBUNAL IN ITA NO. 4459/DEL/07 RELIED UPON BY THE LD. CIT(A) IN SUPPORT OF HIS DEC ISION ON THIS ISSUE HE CONTENDED THAT THE ISSUE INVOLVED IN THE SAID CASE BEFORE THE TRIBUNAL WAS WHETHER THE DEPARTMENT CAN FORCE THE DEPRECIATION O N THE ASSESSEE WHEN IT WAS NOT CLAIMED AND THE SAME BEING ENTIRELY DIFFERE NT THE RELIANCE OF THE LD. CIT(A) THEREON IS CLEARLY MISPLACED. HE SUBMITTED THAT THE ASSESSEE IN THE PRESENT CASE IS A MANUFACTURING CONCERN AND DEPRECI ATION THEREFORE CANNOT BE EXCLUDED FROM THE OPERATING COST FOR THE PURPOSE OF COMPUTING THE OPERATING PROFIT. 14. THE LD. COUNSEL FOR THE ASSESSEE ON THE OTHER HAND STRONGLY RELIED ON THE IMPUGNED ORDER OF THE LD. CIT(A) DELETING THE A DDITION MADE BY THE A.O. ON ACCOUNT OF TRANSFER PRICING ADJUSTMENT. HE CONTE NDED THAT EVEN IF ONLY ONE COMPARABLE CASE IS AVAILABLE FOR THE COMPARABILITY ANALYSIS THE ADJUSTMENT OF +/- 5% IS ALLOWABLE TO THE ASSESSEE AS PER THE PROV ISO TO SECTION 92-C(2) OF THE ACT WHICH INCORPORATES THE SAFE HARBOR RULE. AS REG ARDS THE CAPACITY UTILIZATION ADJUSTMENT HE CONTENDED THAT DEPRECIAT ION BEING THE FIXED COST WAS RIGHTLY EXCLUDED BY THE ASSESSEE FROM THE OPERA TING COST TO WORK OUT THE OPERATING PROFIT IN ORDER TO NULLIFY THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION AND SINCE IT WAS ALSO DONE EVEN IN THE CASE OF COMPARABLES TO WORK OUT THEIR OPERATING PROFIT THE LD. CIT(A) IS FULLY JUSTIFIED IN ACCEPTING THE PLI TAKEN BY THE ASSESSEE AS EBDIT. HE CONTENDED THAT T HE IMPUGNED ORDER OF THE LD. CIT(A) THEREFORE CALLS FOR NO INTERFERENCE AND THE SAME MAY BE UPHELD. 15. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND AL SO PERUSED THE RELEVANT MATERIAL AVAILABLE ON RECORD. IT IS OBSER VED THAT THERE ARE FOUR POINTS WHICH ARISE FOR OUR CONSIDERATION IN RELATION TO TH E ISSUE OF TRANSFER PRICING ADJUSTMENT MADE BY THE A.O. AND DELETED BY THE LD. CIT(A). THE SAME ARE AS UNDER:- ITA NO. 3782/MUM/2011 10 1. SELECTION OF COMPARABLES 2. BENEFIT OF +/- 5% ADJUSTMENT PERMISSIBLE AS PER THE PROVISO TO SECTION 92 C(2) OF THE ACT 3. APPLICATION OF PLI OF COMPARABLES ON THE TOTAL TRA NSACTIONS OR ON THE INTERNATIONAL TRANSACTIONS OF THE ASSESSE E WITH AES 4. ADJUSTMENT FOR THE DIFFERENCE IN CAPACITY UTILIZATI ON. IN THE LIGHT OF THE SUBMISSIONS MADE BEFORE US AS W ELL AS MATERIAL AVAILABLE ON RECORD INCLUDING THE ORDERS OF AUTHORITIES BELOW WE NO PROCEED TO DISCUSS AND DECIDE THESE ISSUES. SELECTION OF COMPARABLES 16. IN THE TP STUDY REPORT THE ASSESSEE COMPANY HA D IDENTIFIED TWO COMPARABLE COMPANIES NAMELY RASIN PLASTICS LTD. AND SANMAR SPECIALITY CHEMICALS LTD. SINCE THE RELEVANT FINANCIAL DATA O F SANMAR SPECIALITY CHEMICALS LTD. FOR THE YEAR UNDER CONSIDERATION WAS NOT AVAILABLE IN PUBLIC DOMAIN AS ADMITTED BY THE ASSESSEE COMPANY ALSO TH E SAID COMPANY WAS REJECTED BY THE TPO AS COMPARABLE AND THERE IS NOTH ING IN THE IMPUGNED ORDER OF THE LD. CIT(A) TO SHOW THAT THIS REJECTION WAS DISPUTED BY THE ASSESSEE. AS PER THE FRESH SEARCH CARRIED OUT BY H IM THE TPO IDENTIFIED AND SELECTED THREE MORE COMPANIES AS COMPARABLES VIZ. 3 M INDIA LIMITED ELANTAS BECK INDIA LIMITED AND DUJODWALLA PAPER CHE MICALS LIMITED AND ADDING THESE THREE COMPARABLES TO RASIN PLASTICS LT D. WHICH WAS IDENTIFIED AS COMPARABLE BY THE ASSESSEE THE COMPARABILITY ANALY SIS WAS DONE BY THE TPO WORKING OUT THEIR AVERAGE OP TO TC AT 13.50% AS AGA INST OP TO TC OF 9.48% IN THE CASE OF THE ASSESSEE. THE ASSESSEE DISPUTED THESE THREE NEW COMPARABLES SELECTED BY THE TPO BEFORE THE LD. CIT( A) BY POINTING OUT THAT 3 M INDIA LIMITED WAS HAVING SIGNIFICANT RELATED PART Y TRANSACTIONS OF 36% OF ITS TOTAL REVENUE WHILE M/S ELANTAS BECK INDIA LIMITED AND DUJODWALLA PAPER CHEMICALS LIMITED WERE FUNCTIONALLY DIFFERENT. ON P ERUSAL OF THE SUBMISSIONS MADE IN THIS REGARD ON BEHALF OF THE ASSESSEE BEFOR E THE LD. CIT(A) WE FIND ITA NO. 3782/MUM/2011 11 THAT 3 M INDIA LIMITED WAS HAVING SIGNIFICANT RELAT ED PARTY TRANSACTIONS OF 36% OF ITS TOTAL REVENUE AND THERE BEING NOTHING BR OUGHT ON RECORD BEFORE US TO DISPUTE THIS POSITION WE ARE OF THE VIEW THAT T HE SAME WAS RIGHTLY REJECTED BY THE LD. CIT(A) AS COMPARABLE. THE REMAINING TWO COMPARABLES NAMELY M/S ELANTAS BECK INDIA LIMITED AND DUJODWALLA PAPER CHE MICALS LIMITED WERE FOUND BY THE LD. CIT(A) TO BE FUNCTIONALLY DIFFEREN T FROM THE ASSESSEE COMPANY ON THE BASIS OF THE SUBMISSIONS MADE BY THE ASSESSE E AND SINCE THE LD. D.R. HAS NOT BEEN ABLE TO REBUT OR CONTROVERT THE FINDIN GS GIVEN BY THE LD. CIT(A) IN THIS CONTEXT WE ARE OF THE VIEW THAT M/S ELANTAS B ECK INDIA LIMITED AS WELL AS DUJODWALLA PAPER CHEMICALS LIMITED WERE RIGHTLY REJECTED BY THE LD. CIT(A) AS COMPARABLES BEING FUNCTIONALLY DIFFERENT. BENEFIT OF +/-5% ADJUSTMENT PERMISSIBLE AS PER PROV ISO TO SECTION 92C(2) OF THE ACT. 17. IN THE PRESENT CASE THE TPO REJECTED ONE OF TH E TWO COMPANIES IDENTIFIED BY THE ASSESSEE AS COMPARABLES IN THE TP STUDY REPORT AND ADDED THREE MORE COMPANIES BY CARRYING OUT FRESH SEARCH A S COMPARABLES. THESE THREE COMPANIES IDENTIFIED BY THE TPO WERE REJECTED BY THE LD. CIT(A) AS COMPARABLES AND SINCE WE HAVE UPHELD THE DECISION O F THE LD. CIT(A) ON THIS ISSUE THERE IS ONLY ONE COMPARABLE FINALLY LEFT FO R THE PURPOSE OF COMPARABILITY ANALYSIS. THE LD. D.R. HAS CONTENDED THAT THERE BEING ONLY ONE COMPANY THAT IS FINALLY ACCEPTED AS COMPARABLE ONL Y ONE COMPARABLE PRICE IS AVAILABLE FOR TP STUDY AND THE PROVISO TO SECTION 9 2-C(2) OF THE ACT IS NOT APPLICABLE. ACCORDING TO HIM THE BENEFIT OF 5% ADJ USTMENT ALLOWABLE TO THE ASSESSEE AS PER THE SAID PROVISO THUS CANNOT BE ALL OWED. IN SUPPORT OF THIS CONTENTION HE HAS RELIED ON VARIOUS DECISIONS OF T HE TRIBUNAL. IN ONE OF SUCH DECISIONS RENDERED IN THE CASE OF HAWORTH (INDIA) P . LTD. 131 ITD 215 IT WAS HELD BY THE TRIBUNAL THAT THE PROVISO TO SECTION 92 C(2) OF THE ACT IS APPLICABLE IN THE CASE WHERE MORE THAN ONE PRICE IS DETERMINED BY THE MOST APPROPRIATE METHOD AND IN THE CASE WHERE ONLY ONE P RICE IS DETERMINED BY THE ITA NO. 3782/MUM/2011 12 MOST APPROPRIATE METHOD BENEFIT OF 5% IS NOT AVAIL ABLE TO THE ASSESSEE. THE SAID DECISION OF THE DELHI BENCH OF THE TRIBUNAL IN THE CASE OF HAWORTH (INDIA) P. LTD. (SUPRA) HAS BEEN FOLLOWED BY THE MUMBAI BEN CH OF THE TRIBUNAL IN THE CASE OF IIML ASSET ADVISORS LTD. IN ITA NO. ITA NO. 5173/MUM/2012 WHEREIN IT WAS HELD THAT WHERE ONLY ONE COMPARABLE WAS FINA LLY SELECTED BY FOLLOWING THE APPROPRIATE METHOD WHICH WAS ACCEPTABLE TO BOTH PARTIES AND IT WAS POSSIBLE TO RECOMPUTE THE ALP ON THE BASIS OF EVEN ONE COMPARABLE THE ASSESSEE WOULD NOT BE ENTITLED TO THE BENEFIT OF 5% RANGE AS PER THE PROVISO TO SECTION 92C(2) OF THE ACT. IN THE CASE OF GENERAL ATLANTIC PVT. LTD. A SIMILAR ISSUE AROSE AGAIN FOR THE CONSIDERATION OF THE TRIB UNAL AND VIDE ITS ORDER DTD. 31-1-2013 PASSED IN ITA NO. 8914/MUM/2010 IT WAS H ELD BY THE TRIBUNAL THAT EVEN THE LANGUAGE OF PROVISO TO SECTION 92C(2) OF THE ACT AS SUBSTITUTED BY THE FINANCE ACT 2009 READ WITH EXPLANATION INSE RTED BY FINANCE ACT 2012 WITH RETROSPECTIVE EFFECT FROM 1-1-2009 MAKES IT CL EAR THAT THE ALP SHALL BE TAKEN TO BE IN THE RANGE OF +/- 5% OF MORE THAN ONE COMPARABLE PRICES AND IF THERE IS ONLY ONE COMPARABLE CONSIDERED IN THE CASE THE BENEFIT UNDER THE SAID PROVISO WOULD NOT BE AVAILABLE. IN OUR OPINIO N THIS ISSUE THUS IS SQUARELY COVERED AGAINST THE ASSESSEE BY THE VARIOU S DECISIONS OF THE TRIBUNAL AND RESPECTFULLY FOLLOWING THE SAME WE HOLD THAT T HERE BEING ONLY ONE COMPARABLE THAT IS FINALLY CONSIDERED IN THE CASE O F THE ASSESSEE FOR THE PURPOSE OF COMPARABILITY ANALYSIS IN ORDER TO DETER MINE THE ALP THE BENEFIT OF +/- 5% ADJUSTMENT AS PER PROVISO TO SECTION 92 C (2) OF THE ACT WOULD NOT BE AVAILABLE TO THE ASSESSEE. THE IMPUGNED ORDER OF T HE LD. CIT(A) TAKING A CONTRARY VIEW ON THIS ISSUE IS THEREFORE REVERSED. APPLICATION OF PLI OF COMPARABLES ON THE TOTAL TRAN SACTIONS OR ON THE INTERNATIONAL TRANSACTIONS OF THE ASSESSEE WITH AES 18. IT IS OBSERVED THAT THIS ISSUE IS COVERED IN FA VOUR OF THE ASSESSEE BY THE VARIOUS DECISIONS OF THE TRIBUNAL WHICH HAVE BEEN F OLLOWED BY THE LD. CIT(A) WHILE GIVING RELIEF TO THE ASSESSEE ON THIS ISSUE V IDE HIS IMPUGNED ORDER. IN ITA NO. 3782/MUM/2011 13 THE PRESENT CASE THE AVERAGE PROFIT MARGIN OF COMP ARABLES WAS APPLIED BY THE TPO TO THE TOTAL COST OF THE ASSESSEE TO DETERMINE THE ALP OF THE SAID TRANSACTIONS AND BASED ON THE ALP SO DETERMINED TH E TP ADJUSTMENT WAS MADE BY HIM. THE LD. CIT(A) HOWEVER ACCEPTED THE STAND OF THE ASSESSEE RELYING ON THE VARIOUS DECISIONS OF THE TRIBUNAL CI TED IN SUPPORT THAT THE PROFIT MARGIN OF COMPARABLES SHOULD BE APPLIED ONLY TO THE VALUE OF INTERNATIONAL TRANSACTIONS OF THE ASSESSEE WITH ITS AES TO DETERMINE THE ALP OF THE SAID TRANSACTIONS AND THE TP ADJUSTMENT HAS TO BE WORKED OUT ON THE BASIS OF ALP SO DETERMINED. IN ONE OF THE DECISIONS RELIED UPON BY THE LD. CIT(A) VIZ DCIT VS. M/S STARLITE (ITA NO. 2279/MUM/ 06) IT WAS HELD BY THE TRIBUNAL THAT THE AVERAGE MARGIN OF PROFIT OF COMP ARABLES DETERMINED BY TNMM MUST BE APPLIED TO THE INTERNATIONAL TRANSACTI ONS OF THE ASSESSEE WITH ITS AES AND NOT TO THE ENTIRE TRANSACTIONS AT ENTER PRISE LEVEL. IN ANOTHER CASE OF IL JIN ELECTRONICS (I) (P) LTD. VS. ACIT (ITA N O. 438 OF 2008) THE CO-ORDINATE BENCH OF THIS TRIBUNAL HELD THAT THE A.O. WAS NOT J USTIFIED IN CALCULATING THE NET PROFIT ON ENTIRE SALES AND DIRECTED THE A.O. TO MAKE ADJUSTMENT ONLY FOR THE DIFFERENCE IN OPERATING PROFIT CALCULATED ON TH E INTERNATIONAL TRANSACTIONS OF THE ASSESSEE WITH ITS AES. TO THE SIMILAR EFFEC T ARE THE DECISIONS OF THE CO- ORDINATE BENCH OF THIS TRIBUNAL IN THE CASE OF UCB INDIA PRIVATE LTD. VS. ACIT (ITA NO. 428 & 429 OF 2007) AND IN THE CASE OF ACIT VS. T TWO INTERNATIONAL PVT. LTD. (ITA NO. 5644 OF 2008). RESPECTFULLY FOL LOWING THE RATIO OF THESE DECISIONS OF THE CO-ORDINATE BENCH OF THIS TRIBUNAL WE UPHOLD THE IMPUGNED ORDER OF THE LD. CIT(A) HOLDING THAT THE PROFIT MAR GIN OF COMPARABLES SHOULD BE APPLIED ONLY TO THE VALUE OF INTERNATIONAL TRANSACT IONS OF THE ASSESSEE WITH ITS AES TO DETERMINE THE ALP OF THE SAID TRANSACTIONS A ND THE TP ADJUSTMENT HAS TO BE WORKED OUT ON THE BASIS OF ALP SO DETERMINED. ADJUSTMENT FOR THE CAPACITY UTILIZATION. 19. THERE BEING DIFFERENCE IN THE CAPACITY UTILIZAT ION OF THE ASSESSEE VIS-- VIS THE COMPARABLES ADJUSTMENT ON ACCOUNT OF CAPAC ITY UTILIZATION WAS ITA NO. 3782/MUM/2011 14 CLAIMED BY THE ASSESSEE. ACCORDING TO THE ASSESSEE IF THE PROFIT MARGIN IS TAKEN BEFORE DEPRECIATION BY ADOPTING EARNING BEFOR E DEPRECIATION INTEREST AND TAX (EBDIT) AS PLI THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFIT MARGIN CAN BE NULLIFIED. THE TPO DID NOT APPROVE TH IS METHOD ADOPTED BY THE ASSESSEE FOR MAKING ADJUSTMENT ON ACCOUNT OF CAPACI TY UTILIZATION WHEREAS THE LD. CIT(A) FOUND THE SAME TO BE ACCEPTABLE HOLD ING THAT THE UNDER UTILIZATION OF CAPACITY RESULTS IN UNDER RECOVERY O F FIXED EXPENSES LIKE DEPRECIATION AND IF THE DEPRECIATION IS EXCLUDED T HE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFIT MARGIN CAN BE NULLIF IED. BEFORE WE PROCEED TO DEAL WITH THE ISSUE OF ADJUSTMENT FOR DIFFERENCE IN CAPACITY UTILIZATION IT IS NECESSARY FIRST TO SEE THE PROCEDURE LAID DOWN FOR CARRYING OUT THE EXERCISE OF COMPARABILITY ANALYSIS AND MAKING SUITABLE ADJUSTME NTS. THIS PROCEDURE AS LAID DOWN IN SECTION 92-C OF THE ACT PROVIDES THAT THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION SHALL BE DETERMINED BY AN Y OF THE METHODS SPECIFIED THEREIN BEING THE MOST APPROPRIATE METHOD AND THE MANNER IN WHICH THE SAID ALP HAS TO BE DETERMINED IS GIVEN IN SECTION 92-C(2 ) OF THE ACT READ WITH RULE 10B OF THE INCOME TAX RULES 1962 IN RESPECT OF EAC H METHOD SEPARATELY. CLAUSE (E) OF RULE 10-B STIPULATES THE MANNER IN WH ICH THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION IS TO BE DETERMINED BY FOLLOWING THE TRANSACTIONAL NET MARGIN METHOD AS UNDER:- (E) TRANSACTIONAL NET MARGIN METHOD BY WHICH - (I) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE FR OM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSO CIATED ENTERPRISE IS COMPUTED IN RELATION TO COSTS INCURRE D OR SALES EFFECTED OR ASSETS EMPLOYED OR TO BE EMPLOYED BY THE ENTERPRISE OR HAVING REGARD TO ANY OTHER RELEVANT B ASE; (II) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE OR BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED TRANSACTION OR A NUMBER OF SUCH TRANSACTIONS IS COM PUTED HAVING REGARD TO THE SAME BASE; (III) THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAUSE (I I) ARISING IN COMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO ITA NO. 3782/MUM/2011 15 TAKE INTO ACCOUNT THE DIFFERENCES IF ANY BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS OR BETWEEN THE ENTERPRIS ES ENTERING INTO SUCH TRANSACTIONS WHICH COULD MATERI ALLY AFFECT THE AMOUNT OF NET PROFIT MARGIN IN THE OPEN MARKET; (IV) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE AN D REFERRED TO IN SUB-CLAUSE (I) IS ESTABLISHED TO BE THE SAME AS THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAUSE (III); (V) THE NET PROFIT MARGIN THUS ESTABLISHED IS THEN TAKE N INTO ACCOUNT TO ARRIVE AT AN ARMS LENGTH PRICE IN RELAT ION TO THE INTERNATIONAL TRANSACTION; 20. KEEPING IN VIEW THE AFORESAID PROVISIONS OF THE RELEVANT RULE WE CAN NOW ENDEAVOR TO CONSIDER HOW AND TO WHAT EXTENT THE DIFFERENCE IN CAPACITY UTILIZATION AFFECTS THE PROFIT MARGIN AND HOW THE A DJUSTMENT ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION CAN APPROPRIATEL Y BE MADE WITHIN THE FRAME- WORK OF RULE 10B. THE ISSUE OF DIFFERENCE IN CAPAC ITY UTILISATION GENERALLY COMES IN THE CASE OF MANUFACTURING CONCERN AND LIKE ANY OTHER BUSINESS UNDERTAKING THE MANUFACTURING CONCERN HAS MAINLY T WO TYPES OF OVERHEADS I.E. FIXED OVERHEADS AND VARIABLE OVERHEADS. THE VA RIABLE OVERHEADS VARY IN PROPORTION TO THE SALES AND THEY THEREFORE DO NOT H AVE ANY EFFECT ON THE PROFIT MARGIN AS A RESULT OF DIFFERENCE IN CAPACITY UTILIZ ATION. THE FIXED OVERHEADS ON THE OTHER HAND DO NOT VARY WITH THE VOLUME OF S ALES AND SINCE THEY REMAIN BY AND LARGE STATIC IRRESPECTIVE OF LEVEL OF CAPACITY UTILIZATION THE PROFIT MARGIN GETS AFFECTED AS A RESULT OF DIFFEREN CE IN CAPACITY UTILIZATION ON THIS COUNT. THE UNDER UTILIZATION OF CAPACITY RESU LTS IN OVER ALLOCATION OR OVER ABSORPTION OF FIXED OVERHEADS RESULTING INTO UNDER- RECOVERY OF FIXED OVERHEADS WHICH ADVERSELY AFFECTS THE PROFIT MARGIN. AS THE LEVEL OF CAPACITY UTILIZATION GOES UP THE RATE OF ALLOCATION OR ABSORPTION OF FI XED OVERHEADS TO SALES COMES DOWN RESULTING INTO HIGHER PROFIT MARGIN. THE FOLLO WING SIMPLE EXAMPLE WOULD FURTHER EXPLAIN THIS POSITION: ITA NO. 3782/MUM/2011 16 INSTALLED CAPACITY IN MONETARY TERMS RS.10 CRORES RS. 10 CRORES RS. 10 CRORES CAPACITY UTILISATION 50% 60% 80% SALES RS. 5 CRORES RS. 6 CRORES RS.8 CRORES VARIABLE OVERHEADS AT 50% RS.2.5 CRORES RS.3 CRORES RS. 4 CRORES FIXED OVERHEADS RS.2 CRORES RS. 2 CRORES RS. 2 CRORES NET PROFIT RS.0.5 CRORES RS. 1 CRORE RS. 2 CRORES PROFIT MARGIN (OP/SALES) 10% 16.67% 25% 21. THE ABOVE EXAMPLE SHOWS THAT THE PROFITABILITY CHANGES WITH THE CHANGE IN THE LEVEL OF CAPACITY UTILIZATION WITH HIGHER PR OFITABILITY AT HIGHER UTILIZATION AND LOWER PROFITABILITY AT LOWER REALIZATION. THIS HAPPENS MAINLY BECAUSE OF HIGHER ALLOCATION OR ABSORPTION OF FIXED OVERHEADS AT LOWER CAPACITY UTILIZATION WHICH COMES DOWN AS THE LEVEL OF CAPACITY UTILIZATI ON GOES UP. FOR INSTANCE AS GIVEN IN THE ABOVE EXAMPLE THE RATE OF ALLOCATI ON OR ABSORPTION OF FIXED OVERHEADS TO SALES IS 40% AT 50% CAPACITY UTILIZATI ON WHILE IT BECOMES 33.33% AT 60% CAPACITY UTILIZATION AND 25% AT 80% C APACITY UTILIZATION GIVING MORE PROFIT MARGIN OF 16.67% AT 60% CAPACITY UTILIZ ATION AND 25% AT 80% CAPACITY UTILIZATION AS AGAINST PROFIT MARGIN OF 10 % AT 50% CAPACITY UTILIZATION. THE DIFFERENCE IN CAPACITY UTILIZATIO N THUS MATERIALLY AFFECTS THE PROFIT MARGIN AND IF THERE IS A DIFFERENCE IN THE L EVEL OF CAPACITY UTILIZATION OF THE ASSESSEE AND THE LEVEL OF CAPACITY UTILIZATION OF THE COMPARABLE COMPANIES ADJUSTMENT IS REQUIRED TO BE MADE TO THE PROFIT MARGIN OF THE COMPARABLES ON ACCOUNT OF DIFFERENCE IN CAPACITY UT ILIZATION AS PER CLAUSE (E)(III) OF SUB-RULE (1) OF RULE 10-B OF THE INCOME TAX RULES 1962. 22. HAVING HELD THAT THE ADJUSTMENT IS REQUIRED TO BE MADE TO THE NET MARGIN OF THE COMPARABLES ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILISATION THE NEXT ISSUE THAT ARISES IS REGARDING THE ADOPTION OF PROPER METHOD BY WHICH THE SAME CAN APPROPRIATELY BE MADE. IN THE PRESENT CASE THE ASSESSEE MADE THIS ADJUSTMENT BY NOT CONSIDERING DEPRECIATION FOR COMPUTING ITS OWN OPERATING PROFIT AS WELL AS THE OPERATING PROFIT OF COMPARABLE. IT WAS DONE BY ITA NO. 3782/MUM/2011 17 TAKING EBDIT AS PLI INSTEAD OF EBIT. ALTHOUGH THIS METHOD ADOPTED BY THE ASSESSEE WAS NOT APPROVED BY THE TPO IT WAS ACCEPT ED BY THE LD. CIT(A) ON THE GROUND THAT THE EFFECT OF DIFFERENCE IN CAPACIT Y UTILIZATION ON PROFITABILITY COULD BE NULLIFIED BY TAKING EBDIT AS PLI INSTEAD O F EBIT. WE ARE UNABLE TO CONCUR WITH THIS VIEW OF THE LD. CIT(A). IN OUR OPI NION WHEN THE PLI IS TAKEN AS OP TO SALES OR OP TO COST OPERATING PROFIT OF T HE ASSESSEE AS WELL AS COMPARABLE CASES BECOMES RELEVANT AND THE DEPRECIAT ION BEING VERY MUCH INTEGRAL PART OF THE OPERATING EXPENSES OF THE MANU FACTURING CONCERN THE SAME CANNOT BE EXCLUDED FOR THE PURPOSE OF COMPUTIN G OPERATING PROFIT. MOREOVER CLAUSE (E)(I) OF SUB RULE (1) OF RULE 10- B REQUIRES THAT THE NET PROFIT MARGIN OF THE ASSESSEE IS TO BE WORKED OUT WHILE CL AUSE (E)(II) OF THE SAID SUB RULE REQUIRES THAT NET PROFIT MARGIN OF THE COMPARA BLES IS WORKED OUT. CLAUSE (E)(III) WHICH PERMITS THE ADJUSTMENTS CLEARLY ST IPULATES THAT ANY ADJUSTMENT ON ACCOUNT OF DIFFERENCES AFFECTING MATERIALLY THE PROFITABILITY IS TO BE MADE TO THE NET PROFIT MARGIN OF THE COMPARABLES AS REFERRE D TO IN CLAUSE (E)(II). BY TAKING THE NET PROFIT MARGIN OF THE ASSESSEE WITHOU T CONSIDERING THE DEPRECIATION IN ORDER TO MAKE ADJUSTMENT ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION WHAT THE ASSESSEE HAS SOUGHT TO DO IS TO MAKE ADJUSTMENT TO THE NET PROFIT MARGIN OF THE ASSESSEE AS REFERRED TO IN CLAUSE (E)(I) OF SUB RULE (1) OF RULE 10B WHICH IN OUR OPINION IS NOT PERMISSIB LE IN ACCORDANCE WITH CLAUSE (E)(III) OF SUB RULE (1) OF RULE 10B. 23. THE QUESTION THAT NOW ARISES IS WHAT IS THE PRO PER METHOD OF MAKING ADJUSTMENT FOR DIFFERENCE IN CAPACITY UTILIZATION W ITHIN THE FRAME WORK GIVEN IN RULE 10B. AS ALREADY DISCUSSED BY US THE DIFFE RENCE IN CAPACITY UTILIZATION AFFECTS THE PROFITABILITY MAINLY BECAUSE OF THE DIF FERENCE IN RATES AT WHICH THE FIXED OVERHEADS ARE ABSORBED OR ALLOCATED DEPENDING ON THE LEVEL OF CAPACITY UTILIZATION. THE EXAMPLE GIVEN BY US CLEARLY DEPICT S THIS POSITION. THE SAID EXAMPLE SHOWS THAT THE ALLOCATION OF FIXED OVERHEAD S AT THE CAPACITY UTILIZATION OF 50% 60% & 80% IS 40% 33.33% & 25% RESPECTIVELY RESULTING ITA NO. 3782/MUM/2011 18 IN THE PROFIT MARGIN OF 10% 16.67% AND 25%. IN OUR OPINION IF THE FIXED OVERHEADS ALLOCATION OR ABSORPTION OF COMPARABLE IS BROUGHT AT THE LEVEL OF THE ASSESSEE IT WOULD NULLIFY THE EFFECT OF DIFFERENC E IN CAPACITY UTILIZATION ON THE PROFIT MARGIN. FOR EXAMPLE IF WE TAKE THE PROFITA BILITY WORKING AT 50% CAPACITY UTILIZATION AS THAT OF THE TESTED PARTY AN D AT CAPACITY UTILIZATION OF 60% AND 80% AS THAT OF THE COMPARABLES AND ADJUST T HE RATE OF ALLOCATION OF FIXED OVERHEADS OF THE COMPARABLES IN ORDER TO BRIN G THE SAME AT PAR (I.E. 40% OF SALES) WITH THE TESTED PARTY THE RESULTANT POSI TION WILL BE AS UNDER:- NET PROFIT RS.1 CRORE RS. 2.00 CRORES LESS ADDITIONAL ALLOCATION OF DEPRECIATION BY TAKING THE RATE OF FIXED OVERHEADS AT 40% OF SALES: RS. 0.40 CRORES RS.1.20 CRORES NET PROFIT AFTER ADJUSTMENT RS. 0.60 CRORES RS. 0. 80 CRORES PROFIT MARGIN AFTER ADJUSTMENT 10% 10% 24. THE ADJUSTMENT THUS CAN BE MADE TO THE PROFIT M ARGIN OF THE COMPARABLES BY ALLOCATING FIXED OVERHEADS AT THE SA ME RATE AT WHICH FIXED OVERHEADS ARE ALLOCATED IN THE CASE OF THE TESTED P ARTY. FOR EXAMPLE IN THE CASE OF A COMPARABLE HAVING 80% CAPACITY UTILIZATIO N THE RATE OF ALLOCATION OF DEPRECIATION IS 25% OF THE SALES AS AGAINST THE RAT E OF ALLOCATION OF FIXED OVERHEADS OF 40% IN THE CASE OF THE TESTED PARTY. I F THE ADJUSTMENT IS MADE IN THE PROFIT MARGIN OF THE SAID COMPARABLES BY ALLOCA TING MORE FIXED OVERHEADS AT 15% OF SALES TO BRING THE RATE OF ALLOCATION OF FIXED OVERHEADS AT PAR WITH THAT OF THE TESTED PARTY THE PROFIT OF THE COMPARA BLE WOULD BE REDUCED BY RS. 1.20 CRORES THEREBY GIVING A NET PROFIT OF RS. 0.80 CRORES WHICH WOULD BRING THE PROFITABILITY TO 10% I.E. AT PAR WITH THE TEST ED PARTY. SIMILARLY IF THE ADJUSTMENT IS MADE IN THE PROFIT MARGIN OF A COMPAR ABLE HAVING 60% CAPACITY UTILIZATION BY ALLOCATING MORE FIXED OVERHEADS AT 6 .67% OF SALES TO BRING THE RATE OF ALLOCATION OF FIXED OVERHEADS AT PAR WITH T HAT OF THE TESTED PARTY THE PROFIT OF THE SAID COMPARABLE WOULD BE REDUCED BY R S. 0.40 CRORES THEREBY ITA NO. 3782/MUM/2011 19 GIVING A NET PROFIT OF RS. 0.60 CRORES WHICH WOULD BRING THE PROFITABILITY TO 10% I.E. AT PART WITH THE TESTED PARTY. 25. HAVING HELD THAT THE ADJUSTMENT ON ACCOUNT OF D IFFERENCE IN CAPACITY UTILIZATION IS REQUIRED TO BE MADE AND HAVING EXPLA INED WITH ILLUSTRATION THAT THE SAME CAN APPROPRIATELY BE MADE BY ABSORBING OR ALLOCATING FIXED OVERHEADS SUCH AS DEPRECIATION ON SALES OF THE COMP ARABLE AT THE SAME RATE AS THAT OF THE TESTED PARTY WE ARE OF THE VIEW THA T SUCH ABSORPTION OR ALLOCATIONS OF FIXED OVERHEADS ON OPERATING COST IN STEAD OF SALES WOULD BE MORE APPROPRIATE AS THE SAME WILL ELIMINATE THE EFF ECT OF DIFFERENCE IN PROFIT MARGIN OR DIFFERENCE IN LEVEL OF STOCK OF FINISHED GOODS IF ANY OF THE TESTED PARTY AND COMPARABLES. 26. IN SO FAR THE PRESENT CASE IS CONCERNED IT IS OBSERVED THAT DEPRECIATION CLAIMED BY THE ASSESSEE IS RS. 6.15 CRORES WHICH IS 4.26% OF ITS OPERATING COST OF RS. 144.13 CRORES. IF THE DEPRECIATION IN CASE O F A COMPARABLE IS ALLOWED AT THE SAME RATE I.E. 4.26% OF ITS OPERATING COST INST EAD OF THE ACTUAL DEPRECIATION CLAIMED IF IT IS LOWER THIS ADJUSTME NT IN OUR OPINION WILL TAKE CARE OF DIFFERENCE IN CAPACITY UTILIZATION. WE ACC ORDINGLY SET ASIDE THE IMPUGNED ORDER OF THE LD. CIT(A) EXCLUDING THE DEP RECIATION ENTIRELY FOR THE PURPOSE OF COMPUTING OPERATING PROFIT AND DIRECT TH E A.O. TO MAKE THE ADJUSTMENT AS GIVEN ABOVE FOR DIFFERENCE IN CAPACI TY UTILIZATION AFTER VERIFYING THE STAND OF THE ASSESSEE THAT THE CAPACITY UTILIZA TION OF COMPARABLE COMPANY FINALLY SELECTED VIZ. RASIN PLASTIC LTD. WAS MORE B Y 10-15% THAN THAT OF THE ASSESSEE DURING THE YEAR UNDER CONSIDERATION. GROU ND NO. 1 OF THE REVENUES APPEAL IS THUS PARTLY ALLOWED WHEREAS GROUND NO. 2 & 3 ARE DISMISSED. 27. IN GROUND NO. 4 THE REVENUE HAS CHALLENGED THE ACTION OF THE LD. CIT(A) IN DELETING THE ADDITION MADE BY THE A.O. TO THE VA LUE OF CLOSING STOCK ON ACCOUNT OF EXCISE DUTY IN TERMS OF PROVISIONS OF SE CTION 145A OF THE ACT. ITA NO. 3782/MUM/2011 20 28. AT THE TIME OF HEARING BEFORE US THE LD. REPRE SENTATIVES OF BOTH THE SIDES HAVE AGREED THAT THIS ISSUE IS SQUARELY COVER ED BY THE DECISION OF THE HONBLE BOMBAY HIGH COURT IN THE CASE OF CIT VS. MA HALAXMI GLASS WORKS PVT. LTD. 318 ITR 116 WHEREIN IT WAS HELD THAT THE ADJUSTMENT ON ACCOUNT OF EXCISE/MODVAT CREDIT IS REQUIRED TO BE MADE AS PER THE PROVISIONS OF SECTION 145A OF THE ACT IN RESPECT OF CLOSING STOCK AS WELL AS OPENING STOCK. IN THE CASE OF MAHAVIR ALLUMINIUM LTD. 297 ITR 727 THE HO NBLE DELHI HIGH COURT HAS ALSO TAKEN A SIMILAR VIEW. RESPECTFULLY FOLLOW ING THE RATIO OF THESE JUDICIAL PRONOUNCEMENTS WE DIRECT THE A.O. TO MAKE THE ADJU STMENT ON ACCOUNT OF EXCISE DUTY TO THE VALUE OF OPENING STOCK AS WELL A S CLOSING STOCK IN ACCORDANCE WITH SECTION 145A OF THE ACT AND MAKE TH E ADDITION IF ANY TO THE TOTAL INCOME OF THE ASSESSEE ON THIS ISSUE. GROUND NO. 4 OF REVENUES APPEAL IS ACCORDINGLY TREATED AS PARTLY ALLOWED FOR STATIS TICAL PURPOSE. 29. THE NEXT ISSUE RAISED BY THE REVENUE IN THIS AP PEAL IS WHETHER FOR THE PURPOSE OF CLAUSE (III) OF EXPLANATION 1 TO SECTION 115 JB OF THE ACT ONE CONSOLIDATED FIGURE OF BROUGHT FORWARD LOSSES OR UN ABSORBED DEPRECIATION FOR THE EARLIER YEARS IS TO BE TAKEN OR THE SAME IS TO BE CONSIDERED ON YEAR TO YEAR BASIS. THIS ISSUE IS RAISED BY THE REVENUE IN GROU ND NO. 5 6 & 7 WHICH READ AS UNDER:- 5. ON THE FACTS AND IN THE CIRCUMSTANCES OF THE C ASE AND IN LAW THE LD. CIT(A) ERRED IN NOT APPRECIATING THE FACT THAT FOR THE PURPOSE OF CLAUSE (III) OF EXPLANATION 1 TO SECTION 11 5JB EL IGIBILITY FOR DEDUCTION IS TO BE CONSIDERED ON YEAR TO YEAR BASIS. 6. ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CA SE AND IN LAW THE LD. CIT(A) ERRED IN HOLDING THAT FOR THE PURPOSE OF CLAUSE (III) OF EXPLANATION 1 TO SECTION 115JB ONE CONSOLIDATED FIG URE OF BROUGHT FORWARD LOSSES OR UNABSORBED DEPRECIATION FOR THE E ARLIER YEARS IN TOTALITY IS TO BE TAKEN AND NOT ON YEAR TO YEAR BAS IS. 7. ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CA SE AND IN LAW THE LD. CIT(A) ERRED IN NOT APPRECIATING THAT THE AO HA D RIGHTLY RECOMPUTED THE BOOK PROFIT U/S.115JB BY RESTRICTING THE DEDUCT ION OF UNABSORBED DEPRECIATION OR BROUGHT FORWARD LOSS AND REDUCED LE SSER OF THE TWO FROM ITA NO. 3782/MUM/2011 21 THE NET PROFIT TO RS.11 39 60 000/- INSTEAD OF RS. 13 91 13 110?- AS CLAIMED IN THE RETURN OF INCOME. 30. AT THE TIME OF HEARING BEFORE US THE LD. REPRE SENTATIVES OF BOTH THE SIDES HAVE AGREED THAT THIS ISSUE IS SQUARELY COVER ED IN FAVOUR OF THE ASSESSEE BY THE DECISION OF THE TRIBUNAL IN THE CASE OF AMLI NE TEXTILES (P) LTD. VS. TPO REPORTED IN (2009) 27 SOT 152 WHICH HAS BEEN RELIED UPON BY THE LD. CIT(A) IN HIS IMPUGNED ORDER TO GIVE RELIEF TO THE ASSESSEE. IN THE SAID CASE A SIMILAR ISSUE HAS BEEN DECIDED BY THE TRIBUNAL IN FAVOUR OF THE ASSESSEE BY OBSERVING AS UNDER:- CLAUSE (III) STATES THAT THE AMOUNT OF LOSS BROUGHT FORWARD OR UNABSORBED DEPRECIATION WHICHEVER IS LESS AS PER B OOKS OF ACCOUNT IS TO BE REDUCES FROM THE NET PROFIT. AS PER THE PLAIN LANGUAGE OF THIS PROVISION IT IS NOTED THAT THE WORD EMPLOYED IN TH E PROVISION IS THE AMOUNT AND NOT THE AMOUNTS OF LOSS BROUGHT FORW ARD OR UNABSORBED DEPRECIATION WHICHEVER IS LESS. THE REFERENCE TO T HE AMOUNT OF BROUGHT FORWARD LOSS OR UNABSORBED DEPRECIATION WHI CHEVER IS LESS SHOWS THE INTENTION OF THE LEGISLATURE FOR CONSIDER ING ONE CONSOLIDATED FIGURE OF BROUGHT FORWARD LOSS OR UNABSORBED DEPREC IATION FOR THE EARLIER YEARS IN TOTALITY AND NOT ON YEAR TO YEAR B ASIS. THE USE OF THE WORD AMOUNT IN SINGULAR CONVEYS THE AIM OF REFERR ING IT TO ONE FIGURE. WHEREVER THE LEGISLATURE DESIRED TO USE THE WORD A MOUNT IN PLURAL IT SPECIFICALLY USED THE WORD AMOUNTS INSTEAD OF THE AMOUNT AS CAN BE SEEN FROM THE HEADING OF SECTION 10 AMOUNTS NOT DEDUCTIBLE. FROM HERE WE CAN EASILY DEDUCE THAT FOR THE PURPOSES OF CLAUSE (III) OF EXPLANATION (1) THE UNABSORBED DEPREDATION FOR ALL THE EARLIER YEARS IS TO BE CLUBBED INTO ONE AMOUNT; AND THE AMOUNT OF BR OUGHT FORWARD LOSS (BEFORE DEPRECIATION) IS ALSO TO BE TAKEN BY SUMMIN G UP ALL THE. FIGURES OF LOSS OF EARLIER YEARS AND THEN THE LOWER OF THE SE TWO AMOUNTS IS TO BE REDUCED FROM THE NET PROFIT AS SHOWN IN THE PROFIT & LOSS ACCOUNT SO AS TO COMPLY WITH THE PRESCRIPTION OF CLAUSE (III) OF EXPLANATION (1). SIMILAR POSITION IS COMING UP FROM THE PRESSING INTO SERVIC E OF THE WORD LOSS IN THIS CLAUSE IN CONTRADISTINCTION TO THE WORD L OSSES AS HAS BEEN DONE IN THE MARGINAL NOTES TO SECTIONS 72 73 74 74A AND 75 ETC. FROM HERE WE GATHER THAT BY USING THE WORDS AMOUNT AND LOSS IN THIS CLAUSE THE POINT HAS BEEN MADE CLEAR THAT IT IS A COMPOSITE FIGURE EACH OF THE UNABSORBED AND BROUGHT FORWARD LOSS THAT ME RITS CONSIDERATION. MOVING STILL FURTHER WE FIND FROM THE LANGUAGE OF T HIS CLAUSE THAT THERE IS NO REFERENCE TO CONSIDERING THE BROUGHT FORWARD LOSS OR UNABSORBED DEPRECIATION ON YEAR TO YEAR BASIS. THERE IS NOTH ING IN THE LANGUAGE OF SECTION WHICH COULD SUGGEST EVEN REMOTELY THAT T HE LEGISLATURE INTENDED TO CONSIDER YEAR-WISE FIGURES. IF IT HAD DESIRED LIKE THAT THEN IT WOULD HAVE BEEN SO STATED IN UNEQUIVOCAL TERMS I N THE PROVISION ITA NO. 3782/MUM/2011 22 ITSELF. IN THE ABSENCE OF ANY SPECIFIC MENTION IN THIS REGARD IN THE CLAUSE WE ARE UNABLE TO INFER SUCH INTENDMENT. SI NCE THE LANGUAGE OF THE SECTION IS CLEAR AND DOES NOT ADMIT OF ANY DOUB T WE ARE NOT PERSUADED TO INTERPRET IT IN THE WAY THE LD. D.R. IMPRESSES UPON US TO DO. 31. RESPECTFULLY FOLLOWING THE DECISION OF THE COOR DINATE BENCH OF THIS TRIBUNAL IN THE CASE OF AMLINE TEXTILES (P) LTD. (S UPRA) WE UPHOLD THE IMPUGNED ORDER OF THE LD. CIT(A) HOLDING THAT THE L OWER OF THE SOLITARY FIGURES OF THE UNABSORBED DEPRECIATION OR LOSS BROUGHT FOR WARD FOR ALL THE EARLIER YEARS TAKEN TOGETHER IS TO BE REDUCED FOR THE PURPO SES OF COMPUTING BOOK PROFIT U/S 115 JB OF THE ACT. GROUND NO. 5 6 & 7 OF THE REVENUES APPEAL ARE ACCORDINGLY DISMISSED. 32. IN THE RESULT APPEAL FILED BY THE REVENUE IS T REATED AS PARTLY ALLOWED. 5 6 #$ 0 74 #$ 8 0 9: ORDER PRONOUNCED IN THE OPEN COURT ON 24 TH JULY 2013 '4 0 23+ ;')6 24-07-2013 3 0 SD/- SD/ - (VIJAY PAL RAO) (P.M. JAGTAP ) & !'# JUDICIAL MEMBER !'# / ACCOUNTANT MEMBER MUMBAI ; ;') DATED 24-07-2013. $.&).!./ RK SR. PS '4 0 .&7% <%+ '4 0 .&7% <%+ '4 0 .&7% <%+ '4 0 .&7% <%+/ COPY OF THE ORDER FORWARDED TO : 1. - / THE APPELLANT 2. ./ - / THE RESPONDENT. 3. = () / THE CIT (A) - 15 MUMBAI 4. = /CIT 8 MUMBAI 5. %$@ .&&) / DR ITAT MUMBAI K BENCH 6. A* B / GUARD FILE. '4)! '4)! '4)! '4)! / BY ORDER !/% .& //TRUE COPY// C C C C/ // /!9 !9 !9 !9 ( DY./ASSTT. REGISTRAR) / ITAT MUMBAI