Transfer Pricing: Adjustment to profit margin for “capacity underutilization” can be made. In choosing comparables, there cannot be a cherry picking for deciding parameters of rejection. All comparables must face the same test

(i) Under Rule 10B (1)(e)(ii), an adjustment to the net profit margin has to be made for “capacity underutilization”. Capacity underutilization by enterprises is an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerned, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment. On facts, the CIT(A)’s approach is reasonable and the adjustments are on a conceptually sound basis;

(ii) In view of Quark Systems 132 TTJ 1 SB there is no estoppel against an assessee changing his stand as regards the acceptance or rejection of a comparable. However, there cannot be a cherry picking for deciding parameters of rejection of a comparable, and the parameters have to be broad enough of being general application. In the scheme of things envisaged under the TNMM, it is inevitable that there will be some differences between the comparables and the tested party but the impact of these differences is substantially mitigated by the averaging. If a comparable is being sought to be rejected on the ground of its differences vis-à-vis the tested party, similar criteria must be adopted for deciding suitability of other comparables as well. It cannot be open to any judicial authority to reject a comparable on the ground that the comparable has significant differences vis-à-vis the tested party, unless the differences are broad enough of general application, are such as materially affecting the profitability, as not being capable of reasonably accurate adjustments to eliminate the impact of such differences, and as are also not found in other comparables. All the comparables must face the same test on which comparability of a particular comparable is being sought to be rejected.