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 ITO vs. Vikram A. Pradhan (ITAT Mumbai)

HCL Technologies BPO Services Ltd., (Now stands amalgamated with HCL Technologies Limited), 806, Sidharth, 96, Nehru Place,New Delhi-110 019 Vs. ACIT, CC-2, New Delhi
July, 13th 2015
           IN THE INCOME TAX APPELLATE TRIBUNAL
                (DELHI BENCH `I-2', NEW DELHI)

           BEFORE SHRI I. C. SUDHIR, JUDICIAL MEMBER
      AND SHRI INTURI RAMA RAO, ACCOUNTANT MEMBER
                        I.T.A. No.3547/Del/202010
                         Assessment year : 2003-04
HCL Technologies BPO Services Ltd.,         Vs. ACIT, CC-2,
(Now stands amalgamated with                     New Delhi
HCL Technologies Limited),
806, Sidharth, 96, Nehru Place,
New Delhi-110 019
GIR / PAN:AAAOE1028C

                       I.T.A.No. 5071/Del/2010
                      (Assessment Year 2003-04)
ACIT, CC-2,            Vs. HCL Technologies BPO Services Ltd.,
New Delhi                    806, Sidharth 96, Nehru Place,
                             New Delhi-110 019
              (Appellant)                   (Respondent)

     Assessee by :     ShriAjay Vohra, Sr. Adv.
                       Shri Neeraj Jain, Adv &
                       Ms. Deepika Agarwal, CA
     Department by :   ShriVijay Chaudhary, Sr. DR

Date of hearing       :     11.06.2015
Date of pronouncement :     10.07.2015

                              ORDER

PER INTURI RAMA RAO, AM:

     These are cross appeals filed by assessee company in I.T.A. No.
3547/Del/2010 as well as Revenue in I.T.A. No. 5071/Del/2010 for the
Assessment Year 2003-04. These appeals involve the issue of Transfer
Pricing Adjustment (TPA) for the Assessment Year 2003-04. The Revenue
                                      2         ITA No.3547, 5071/Del/2010


had come up with the present appeal challenging the order of Ld. CIT(A)
that the TPA should be restricted to gross revenue receipt by the associate
enterprises from its customers.
2.    We first take up the Revenue's appeal in I.T.A. No. 5071/Del/2010.
The grounds of appeal raised by Revenue are noted below:
            "1. On the facts and in the circumstances of the case, the CIT
      (A) has erred in law and on facts in restricting the addition of
      Rs.1703,05,993/- to Rs. 1,19,60,457/-made by the Assessing officer on
      the basis of adjustment computed by the TPO u/s 92CA(3) of the
      Income tax Act, 1961.
            2.      On the facts and in the circumstances of the case, the
      CIT (A) has erred in law and on facts as he has failed to appreciated
      the fact that when the com parables were making average profit @
      13.56% then the assessee would have earned the same profit in
      international transactions?"

3.    The brief facts of the case are that the appellant is a private limited
company and is engaged in providing IT Enabled Services (ITES) e.g.
voice/web based contact and front office services (hereinafter referred as
business process outsourcing (BPO) services). For the relevant previous
year, the return of income of the appellant was filed declaring loss of
Rs.12,85,57,867/-.   The appellant had during the relevant previous year
entered into the international transaction of provision of information
technology enabled services, amounting to Rs.13,06,79,399/- with the
various associated enterprises. For application of TNMM, the appellant was
considered to be the tested party and operating profit/total cost was taken as
the profit level indicator (PLI). The operating results of the appellant were
computed as follows:
           Operating income                              209,032,558
           Less: Operating expenses
           Personnel expenses                            13,38,59,484
                                          3           ITA No.3547, 5071/Del/2010


            Administration selling & other expenses           15,13,90,147
            Finance charges                                       7,68,060
            Depreciation                                       4,42,53,507
            Miscellaneous expense written off                     37,71,203
            Total Operating Cost                              33,40,42,401
            Operating profit                                  12,50,09,843

            Operating profit ratio                            (-)37.34%



4.    The assessee had conducted transfer pricing analysis by using
multiple year data of previous financial year in which data of the 3 years is
on actual basis and for 2 years on project basis. The appellant also selected
the TNMM to determine the arms length price for the transactions with AE
on transactions and for the application of TNMM, the appellant selected
........ operating profit /on total cost was taken as profit level indicator (PLI).
5.    For application of TNMM, the appellant identified the eight
comparable companies engaged in rendering voice based I web based
BPO/ITES. Further, the appellant considered the Profit Level Indicator
("PLI"), i.e., Operating Profit /Total Cost of the comparable companies for
the financial years 2001-02 and 2002-03, as under:


S. No. Name of the Company                Margins (OP/TC)             Weighted
                                          2003         2002           average
1.    Ace Software Exports                11.64%       17.63%         14.88%
2.    Allsec Technologies Ltd             12.55%       9.53%          11.65%
3.    Apex Logical Data                   14.30%       22.26%         17.80%
4.    Compudyne 0.18%                     52.78%       20.05%
      Winfosystems Ltd.
5.    Fortune Infotech Limited            107.46%        68.03%       96.87%
6.    Nucleus Netsoft and GIS             (17.70) %      (10.37) %    (13.92)%
      India Limited
7.    Twinstar Software Exports           (73.35) %      (25.81) %    (45.80)%
      Limited
8.    Zigma Software Limited              0.78%.         17.05%       6.96%
      Mean ·                              6.98%          1.8.89%      13.56%
                                               4     ITA No.3547, 5071/Del/2010




6.     The actual operating profits margin (OPITC) was· (-) 37.35% in the
financial year 2002-03, (-)2.94% in 2003-04 and (+)20.94% in 2004-05.
Further, the projected operating profits margin (OPITC) was 19.14% in the
financial year 2005-06 and 18.29% in 2006-07. The weighted average
operating margin or these five financial years was computed as 14.09%. The
weighted operating" profit on total cost margin of 14-.09% during the
abovementioned financial ears, being higher than that of the comparable
companies at 13.56%, the "international transactions" of rendering business
process outsourcing services were considered being at arm's length.


7.     On noting of above transactions, the A.O. made reference to transfer
pricing officer. The Transfer Pricing Officer (TPO), however, in his order
held that the arm's length operating profit to the total cost ratio in the above
business being 13.56%, viz., average operating profit / cost margin of 8
companies was considered as comparable by the TPO. The TPO
accordingly, in the order passed under section 92CA(3) of the Act,
determined adjustment of Rs. 17,03,05,993 to the arm's length price of'
'international transactions' of provision of business process outsourcing
services applying TNMM, as under:


Calculation of arm's length price                                      Amount
Total operating cost                                           Rs. 33,40,42,401
Arm's length margin                                            13.56%
Profit which the appellant would have earned Rs.33,40,42,401   13.56%
                                                               Rs. 4,52,96,150
Less: Operating loss posted by the appellant                   Rs. (-)12,50,09,843
Difference                                                     Rs.17,03,05,993
                                     5          ITA No.3547, 5071/Del/2010


8.   The TPO held in this regards as follows:

     "6.0 In the transfer pricing approach the assessee has used data for
     five financial years out of which data of three years is on actual basis
     and for two years on projected basis. Such kind of approach
     permitting use of financial data for multiple years' of the taxpayer for
     working operating profits is not provided in the Indian Transfer,
     Pricing regulations. The provisions of Rule 108(1)(e) of Income Tax
     rules contains method of application of Transactional Net Margin
     Method. It emphasizes use of data for the year in which transaction
     took place. It may further be mentioned that Rule 108(4) categorically
     restricts that the data for the comparables should be
     contemporaneous 'and drily in exceptional circumstances data for two
     prior years can be used along with data for the year under
     consideration. In fact all the provisions emphatically and with no
     ambiguity cast an obligation of benchmarking transaction on the
     basis of information as close as possible to the year in which the with
     the AE(s)' has been entered into international transaction. IT is
     understandable that since in. modern economics situations change so
     fast, use of non contemporaneous data can throw up slanted results.

     6.1 In order to compare operating margins the assessee has used data
     of eight comparable companies using data' for the year ending March
     2002 and March 2003 in each case. The data for multiple years has
     been used on the argument that it is permitted as per rule 108(4) of
     Income tax rules. In this case since the assessee company is in its start
     up phase therefore special conditions of even out results of more than
     one year of financial performance exist as enshrined in proviso to the
     above said rule deserving use of financial data for the multiple year.
     Therefore, the approach of the assessee in respect of use of multiple
     year data of comparables is not disturbed. It is also not out of place to
     mention that the comparables used by the assessee company has
     functional and product differences with the assessee company but for
     the year under consideration these comparables are not being
     disturbed for the reasons that the assessee company has apparently
     chosen best possible comparables which could functionally take care
     of start up phase of the assessee company. Some of these comparables
     are persistently loss making and are predominantly into hardware but
     since in the transfer pricing proceedings the assessee company has
                                          6        ITA No.3547, 5071/Del/2010


       been vehemently arguing that during the year assessee was deploying
       assets and manpower to build the facilities for IT Enabled Services,
       therefore, to pass the benefit of any such functional difference
       between the assessee and the comparables the approach of the
       assessee for the year under reference is not disturbed being the start
       up phase. The eight comparables adopted by the assessee for
       Transactional Net Margin Method are accepted for year under
       consideration only for the specific reasons mentioned above."

9.     The A.O. based on the report of TPO made addition of
Rs.17,03,05,993/- on account of transfer pricing adjustment. Aggrieved by
the said order appeal was filed before Ld. CIT(A).           However, Ld. cia
accepted the plea of assessee company that Transfer Pricing Adjustment
should be actually restricted to the amount actually retained by associated
enterprises.
10.    It was submitted that from the gross revenue received from the end
customers in respect of various contracts, the associated enterprise retained
in aggregate only a sum' of Rs.1,19,60,457 at their end the balance amount
has been passed on to the appellant, as follows:
Associated Enterprises      Gross             Amount            Net amount
                            Billing to        Retained by AE    remitted to
                            End-              Amount            HCL-BPO
                            Customer          INR          %______________
HCL-AMERICA                 71,073,269        7,107,327    10% 63,965,942
                            15,507,867        -            0%   15,507,867
                            431,660              28,650    7%   403,010
        Sub Total           87,012,796        7,135,977         79,876,819
        HCL T NI            23,280,234        2,328,023    10% 20,952,210
Infosystem America          5,412,892           541,289    10%   4,871,603
Infinet Acquisition Revenue 18,796,957        1,879,696    10% 16,917,261
HCLT Europe                 7,547,211            75,472    1%    7,471,739
Grand Total                 142,050,089       11,960,457        130,089,632
                                       7        ITA No.3547, 5071/Del/2010





11.   Without prejudice to the assessee company's contention that the
adjustment made by the TPO in not sustainable, it was submitted that the
adjustment at best could be made only to the extent of Rs. 11,960,457, being
the amount which has been retained by the associated enterprise.
12.   The Ld. CIT(A) in his order restricted the Transfer Pricing adjustment
to Rs. 1.19 crores holding as under:
      "The Transfer Pricing Officer has computed an adjustment of Rs.
      17.04 crores while the value of international transactions is Rs.
      13,00,89,632. The total revenue received by the associated enterprises
      in respect of BPO services rendered by the appellant amounting to
      Rs.13,00,89,632 is Rs.14,20,50,089. In other words, the associated
      enterprise has retained Rs. 1, 19,60,457 out of the total proceeds
      received from the customers. The adjustment computed by the TPO in
      the order passed under section 92CA(3) of the Act at best cannot
      exceed the net amount retained by the associated enterprises in
      respect 'of international transactions, i.e., gross revenue' received
      from the end customers less amount paid' to the appellant and, other
      operating expenses. It is observed that the gross revenue received
      from the end customers in respect of various contracts, the associated
      enterprise have retained only Rs. 1,19,60,457 at their end and the
      balance has been passed on to the appellant."

      12.3 The issue has been considered in the recent decision of Delhi
      Bench of the Tribunal in the case of DCIT vs. Global Vantedge P.
      Lid., wherein, the Tribunal held that adjustment on account of arm's
      length price of international transactions cannot exceed the maximum
      arm's length price, i.e., the amount received by the associated
      enterprise from the customer and the actual value of international
      transactions, i.e., the amount received by the assessee in respect of
      international transactions.
      12.4 In view of the same I am of the considered view that the
      adjustment to the income of the appellant has to be restricted to Rs. 1,
      19,60,457- being the amount retained by the associated enterprises."
                                      8          ITA No.3547, 5071/Del/2010


13.   Aggrieved with this order, the Revenue had come up in the present
appeal. Ld. D.R. placed reliance on the order of Ld. CIT(A) and had prayed
for quashing of CIT(A)'s order on this issue. On the other hand, Ld. Sr.,
Counsel submitted that the appellant could not have expected to receive
from the customers of the AEs of the appellant, anything more than the
amount paid by some customer to the AE, if the appellant were to be obtain
the contracts for services from the customers directly, i.e., without the
involvement of the AEs of the appellant. Thus, at the most the consideration
received by the appellant from the AEs may be replaced by the consideration
received by the AEs from its customers, for the services provided by the
appellant; the price charged by AEs to the customers being the CUP.
Reliance is placed in this regard on the decision of the Hon'ble Delhi High
Court in the case of Sony India P. Ltd. vs. CBDT (Delhi) ; 288 ITR 52 has at
pages 61-62, observed as under:
      "The concept of transfer pricing leading to tax avoidance has been
      acknowledged in the Act only recently. It is a concomitant of the
      operations of multinational corporations (MNCs) that set up base by
      incorporating a local subsidiary in a country where they seek to
      operate. It is often seen that the MNC transfers goods and services to
      its local subsidiary at a price not reflective of the market price (or
      arm's length price as if is referred to in the present context) and in
      turn the subsidiary is able to avoid, partly or wholly, payment of the
      local tax, Alth9ugh the expression "transfer price" has not been
      defined in the Act,' it is 'understood to mean "that price which is
      arrived at when two associated or related' enterprises deal with each
      other".

14.   Reference was made to the Finance Minister's Budget Speech for the
year 2001 that the presence of multinational enterprises in India and their
ability to allocate profits in different jurisdictions by controlling prices in
intra-group transactions has made the issue of transfer pricing a matter of
                                       9         ITA No.3547, 5071/Del/2010


serious concern.   The purpose of inserting these provisions is therefore to
determine the arm's length price (ALP) of an international transaction
involving an MNC and its local associate."
15.   Reliance is placed on the decision of Delhi Bench of the Tribunal in
the case of DCIT vs Global Vantedge P. Lid., (ITA No. 1432 &
2321/0ell2009 and 116/0eI/2011), wherein, the Hon'ble Tribunal held that
adjustment on account of arm's length price of international transactions
cannot exceed the amount received by the associated enterprise from the
customer and the actual value of international transactions, i.e., the amount
received by the assessee in respect of international transactions. The Hon'ble
Jurisdictional High Court vide order dated 14-03-2013 (in ITA Nos.
1828/2010, 1829/2010 & 1254/2011) had dismissed the Revenue's appeal
against the said order of the Tribunal. The Special Leave Petition (SLP) of
the Revenue against the said order has also been dismissed by the Supreme
Court vide order dated 02-01-2014 (CC No. 22166 of 2013).
16.   Further reliance in this regard is placed on the following observation
of the Hon'ble Delhi bench of the Tribunal in the case of Li & Fung (India)
Pvt. Ltd. vs. DC IT (ITA No 5156/DeI/2010):
17.   The Hon'ble Delhi High Court recently vide order dated 16-12-2013
(in ITA No.306/2012), while adjudicating on the said decision of the
Tribunal, held in paragraph 40 of the order that "the approach of the TPO
arid the tax authorities in essence imputes notional adjustment / income in
the assessee's hands on the basis of a fixed percentage of the free on board
value of export made by unrelated party vendors. " .....
                                     10         ITA No.3547, 5071/Del/2010


18.   Reliance in this regard is also placed on the recent decision of Delhi
Bench of the Tribunal in the case of Hyper Quality India Pvt. Ltd. vs. ACIT
(ITA No. 5630/0ell2011 ), wherein, it has been held as under:
      "7.      Ld. TPO erred in evaluating FAR (Functions performed,
      Assets. employed and Risk assumed) analysis which has been
      summarily confirmed by DRP. To support its case, assessee furnished
      split financials of the appellant and its AE. Whereas the appellant has
      been .able to earn profit in India its counterpart the AE has
      continuously sustained losses. There being no element of profit in the
      hands of the AE, there is no case of shifting of profits, practicable or
      probable. Invoking a higher ALP on the appellant is only anticipatory
      and complete ignorance of fact. The facts and figures produced before
      the Ld. TPO establish that there is no commercial profit available in
      the hands of the AE. In absence of profit availability, the any
      enhancement of the ALP results in artificial profit anticipated by the
      Ld. TPO and not earned by the Appellant. The order of the LD, TPO
      in enhancing the ALP offered by the appellant is in ignorance of valid
      FAR and factual considerations and is bad in law and facts."

19.   Reliance in this regard is placed on the recent decision of Delhi High
Court in case of Sony Ericsson Mobile Communications India Pvt. Ltd. vs.
CIT III (ITA No. 16/2014) where in it has been held that the arm's length
seeks to correct distortion and shifting of profits of tax the actual income
earned by a resident. The Hon'ble Delhi High Court held as under:
      '77. As a concept and principle Chapter X does not artificially
      broaden, expand or deviate from the concept of "real income". "Real
      income", as held by the Supreme Court in Poona Electricity Supply
      Company Limited versus CIT, [1965J 57 ITR 521 (SC), means profits
      arrived at on commercial principles, subject to the provisions of the
      Act. Profits and gains should be true and correct profits and gains,
      neither under nor over stated. Arm's length price seeks to correct
      distortion and shifting of profits to tax the actual income earned by a
      resident/domestic AE. The profit which would have accrued had arm's
      length conditions prevailed is brought to tax. Misreporting, if any, on
                                       11            ITA No.3547, 5071/Del/2010


      account of non-arm's length conditions resulting in lower profits, is
      corrected.
                                        XXX
      (xii) When segmentation or segregation of a bundled transaction is
      required, the question of set off and apportionment must be examined
      realistically and with a pragmatic approach. Transfer pricing is an
      income allocating exercise to prevent artificial shifting of net incomes
      of controlled taxpayers and to place them on parity with uncontrolled,
      unrelated taxpayers. The exercise undertaken should not result in over
      or double taxation. Thus, the Assessing Officer/TPO can segregate
      AMP expenses as an independent international transaction, but only
      after elucidating grounds and reasons for not accepting the bunching
      adopted by the assessed, and examining and giving benefit of set off.
      Section 92(3) does not bar or prohibit set off."

20.   In view of the aforesaid, it is respectfully submitted that the
adjustment shall be restricted to Rs. 1.19 crores.
21. We have head rival submissions and perused the material on record.
Ld. CIT(A) had followed the ratio laid down in the case of Global Ventedge
P. Ltd. (supra) (in I.T.A. No. 1432 & 2321 / Del/2009 and 116/Del/2011).
This decision was affirmed by both Hon'ble High Court and Hon'ble
Supreme Court and his ratio was followed in subsequent decisions as
submitted earlier and, therefore, the order of Ld. CIT(A) on this issue is
reasonable and we do not find any reason to interfere with this finding of Ld.
CIT(A) and hence, the grounds of appeal filed by revenue are dismissed.
Accordingly, appeal filed by revenue is dismissed.

I.T.A.No. 3547/Del/2010:
22. Now, we deal with the appeal filed by assessee in I.T.A. No.
3547/Del/2010. The assessee has raised following grounds of appeal:
      "1. That the learned Commissioner of Income-tax (Appeals) erred
      both on facts and also in law in confirming the addition to the tune of
      Rs.l,19,60,457/- which the learned Transfer Pricing Officer ("TPO")
      has made in the case of the appellant for the impugned assessment
      year.
                                     12         ITA No.3547, 5071/Del/2010


      2.      That the learned Commissioner of Income-tax (Appeals) erred
      both on facts and in law in failing to appreciate the fact that the
      approach which the appellant had adopted by taking a weighted
      average of its operating margins over a period of 5 years (including
      the impugned financial year) of business cycle and then comparing
      the same with the arithmetic mean of the companies selected as
      comparable companies for applying the TNMM as the most
      appropriate method is in conformity with the well established OECD
      guidelines in case of Start-up Companies.
      3.      That the learned Commissioner of Income-tax (Appeals) erred
      in failing to appreciate that since the appellant was a start up
      enterprise and the impugned financial year was effectively the first
      year of commencement of operations by the appellant, there was no
      justification for drawing an adverse inference by the learned TPO
      regarding the net margin of the appellant merely by comparing the
      appellant with the other companies which were well established
      companies.
      4.      That the learned Commissioner of Income-tax (Appeals) erred
      in ignoring the fact that since the profits of the appellant were
      deductible under Section 10A of the Income Tax Act, 1961, there was
      no motive on the part of the appellant to divert its profits outside
      India.
      5.      That, without prejudice, the learned Commissioner of Income-
      tax (Appeals) erred in concluding that the TPA has correctly not
      allowed the variation to the extent of (+1-) 5%, while determining the
      arm's length price of the international transactions, in the case of the
      appellant."

23.   The main grounds raised by the assessee in its appeal relate to the
adjustment of operating profit as well as selection of comparables. During
the course of appellate proceedings, Ld. Counsel for the Assessee had not
pressed other grounds relating to adjustment of operating profit. The factual
matrix relating to the grounds of appeal is noted below:
24.   Computation of Operating Profit Margin of the appellant:
                                          13      ITA No.3547, 5071/Del/2010


The appellant, it is submitted, is engaged in the business of software
development and has set up a Business Process Outsourcing (BPO) unit for
rendering IT enabled services during the previous year relevant to
assessment year 2003-04. The relevant previous year, i.e. previous year
2002-03 was, thus, the first full year of operation of the BPO unit of the
appellant. It is submitted that during the previous year 2002-03, the appellant
was a start up enterprise, due adjustment ought to be made of the start-up/
one-time costs incurred, which inevitably lead to losses. It is submitted that
operating profit/ loss of the appellant for the relevant previous year are
required to be adjusted to exclude items of abnormal cost / short fall in
revenue (owing to lower rate paid to the appellant as start up) to determine
the normal profit that could have been earned by the appellant for the
purpose of benchmarking with other companies which are not in start-up
stage.
25.      In case adjustment of the extra-ordinary expenses and considering the
average expenses that would have been incurred in the normal operations,
the operating profit margin of the appellant works out to 15% as follows:



Particulars-               Total               Optimum            Excess /
                                                                   Deficit -
Direct / Indirect          18,26,67,573
Infinet Acquisition   .    1,69,17,261
WIP                           94,47,723
Total Sales                20,90,32,557        22,77,90,205        (1,87,57,647)
Salary                     13,38,59,483        10,45,16,279       2,93,43,204
                                  64%             50%                14%
Dep                        4,42,53,507         2,29,93,581        2,12,59,926
                                  21%                 11%                 10%
OAG                        15,13,90,147        8,49,41,671        6,64,48,476
                                  72%                 41%                 32%
Finance Charges            7,68,060              7,68,060                 -
                                  0%                  0%                  0%
                                       14         ITA No.3547, 5071/Del/2010


Misc. Exp. W /0           37,71,203            37,71,203           -
                                 2%                   2%                  0%
Total Cost                33,40,42,402         21,69,90,796        11,70,5t,606
                                 160%                 104%         56%
Operating                 (12,50,09,844)       1,07,99,409         (13,58,09;254)
Profit/(Loss)                    -60%                 5%


26.    It is respectfully submitted that the TPO for application of TNMM
considered the operating profit margin of the appellant at a loss of Rs.(-)
12,50,09,843 without excluding from the operating results the aforesaid
extra ordinary expenses/loss.
27.    It is respectfully submitted that for the purpose of benchmarking the
international transactions, it is imperative that the effect of such
underutilization of capacity/excess fixed costs is eliminated, while
computing the operating margins of the appellant.
28.    Rule 10B(3) of the Rules provides that an appropriate adjustment is
required to be made to account for the differences between the controlled
and uncontrolled transactions:
       "An uncontrolled transaction shall be compara.ble to an international
       transaction if--
             (i) none of the differences, if any, between the transactions
       being compared, or between the enterprises entering into such
       transactions are likely to materially affect the price or cost charged or
       paid in, or the profit arising from, such transactions in the open
       market; or
             (ii) Reasonably accurate adjustments can be made to
       eliminate the material effects of such differences."

29.    Reliance in this regard is also placed on the recent decision of
Chennai Bench of the Tribunal in the case of Mando India Steering Systems
Pvt. Ltd. vs. ACIT (ITA No. 2092/Mds/2012), wherein, the Hon'ble Bench
has remitted the issue back to the file of the assessing officer with a direction
                                       15        ITA No.3547, 5071/Del/2010


to consider the claim of the assessee with respect to idle capacity adjustment
during the relevant period while determining the ALP cost. The relevant
extract of the decision reads as under:
      "We are of the considered view that under-utilization of production
      capacity in the initial years is a vital factor which has been ignored by
      the authorities below while determining the ALP cost. The TPO
      should have made allowance for the higher overhead expenditure
      during the initial period of production. In view of the above, we deem
      it appropriate to remit this issue back to the Assessing Officer with a
      direction to consider the claim of the assessee with respect to idle
      capacity adjustment during the relevant period while determining the
      ALP cost. The assessee is also directed to produce relevant documents
      in comparable units for the necessary analysis. The appeal of the
      assessee is allowed for statistical purposes in the aforesaid terms."

30.   Reliance in this regard is placed on the decision of Pune Bench of the
Tribunal in the case of Amdocs Business Services Pvt. Ltd. vs. DCIT (ITA
No. 14212/PN/11), wherein, the Tribunal allowed economic adjustment on
account of under capacity utilization holding that the appellant was in start
up phase during the assessment year consideration. The relevant extract of
the decision is reproduced as under:
      "9. The next major point made out by the appellant is that this being
      the first full year of operation, the assessee had incurred certain
      expenditure which are start-up costs and cannot be fully recovered in
      the instant year itself, and such an expenditure has abnormally
      affected the profit margin. It is also canvassed that due to the start-up
      year the capacity utilization was not satisfactory, whereas its
      profitability has been bench marked against comparables which are
      established entities -and have been set up over the years. The plea set-
      up by the assessee for economic adjustments on account of under
      capacity utilization and being in start up phase, is not something
      which is unreasonable and neither it is otiose to the mechanism of
      transfer pricing assessments. In fact, in principle, the plea of the
      assessee is in line with the decisions of the Tribunal in the, case of
      Global venttedge P. Ltd v. DCIT in ITA Nos. 1763-2764IDel/09 (Del);
                                      16         ITA No.3547, 5071/Del/2010


      Brintons Carpets' Asia (P) Ltd v. DCIT 139 TT J -177; and, Skoda,
      Auto India P. Ltd. v. A CIT 122 TT J 699. In our view, the matter
      requiring factual appreciation, the same is remanded back to the file
      of the Assessing Officer, who shall consider the propositions put forth
      by the assessee and allow appropriate economic adjustments on a
      reasonable basis."

31.   On the same lines, Delhi Bench of the Tribunal in the case of Global
Turbine Services Inc. vs. ADIT (ITA No. 3484/0e1/2011) allowed economic
adjustment on-account of under capacity utilization considering the fact that
the year under consideration was the first full year of operation of the
appellant. Relevant extract of the decision reads as under:
      "10. -We have heard the rival contentions and perused the material
      available on record. The suitable adjustment for non-utilisation of
      capacity is to be taken in to account after considering the ALP while
      working out TP adjustment, this proposition has been held by co-
      ordinate Bench in the case of the Amdocs Business Services (P.) Ltd.
      (supra) and various other cases as cited here in above .
      11. In the given facts and circumstances it was required on the part of
      the lower authorities to have given due effect to under capacity
      utilization of the assessee which has not been done TPO for
      adjustment for ALP determination. In view of the facts and
      circumstances we are inclined to set aside the matter and restore the
      issue of under capacity utilization back to the file of the Assessing
      Officer ITPO to decide the same afresh after giving assessee adequate
      opportunity of being heard and to file the necessary evidence on this
      behalf. Needless to say that a proper and speaking order will be
      passed deciding the issue in accordance with law."

32.   Reliance in this regard is placed on the following observation of the
Hon'ble Mumbai Bench of the Tribunal in the case of ACIT vs. Fiat India
Pvt. Ltd (ITA no 1848/Mum/2009):
      "As rightly held by the Id. CIT(A), the said submission made by the
      appellant is sufficient to demonstrate that there was a material
      difference in the facts of the appellant's case and that of the
                                     17         ITA No.3547, 5071/Del/2010


      comparable cases in terms of capacity utilization as well as in other
      terms. Appropriate adjustments thus were required to be made to
      eliminate such differences"

33.   Further, the Hon'ble Pune Bench of the of Tribunal in the case of
Brintons Carpers Asia Pvt. Ltd. vs. ACIT ITA. No. 1296/PN/10) while
allowing· adjustment for idle capacity caused due to labour unrest/strike and
relying upon the above observation of the Mumbai Tribunal held as follows:
      "15. From the above, it is clear the AO has authority vide clause (iii)
      above to make the adjustments. Such adjustments are necessary only
      to remove or minimize the differences in the comparable or anomaly
      in' the said comparable.
      -Such adjustments are authenticated by the OECD guidelines too. In
      this regard, we have perused the important findings of the Tribunal in
      the case of the Fiat India P Ltd (supra) placed at page 191 of the
      paper book. For the sake completeness, the same is reproduced as
      under.
      .......as regards the adjustments made by the appellant to work out its
      operating margin for comparing the same with the profit margin of
      comparable cases, it was held that there was a material difference in
      the facts of the appellant's case and that of the comparable cases in
      terms of capacity utilization as well as in other terms. Appropriate
      adjustments thus were required to be made to eliminate such
      differences. Further, the TPO himself has allowed similar adjustments
      made by the appellant in the immediate preceding years i.e. AY 2002-
      03, 2003-04 as well as in the immediate succeeding years i.e. 2005-06
      and 2006-07 wherein the facts involved were similar to that of the
      year under consideration i.e. AY 2004-05;
      + accordingly, no infirmity is found in the impugned order of the
      CIT(A) as the adjustments made by the appellant in TNMM analysis
      were reasonable and accurate and as reflected in the said analysis,
      international transactions made by the appellant company with its
      associated concerns during the year under consideration were at
      arm's length requiring no adjustment/addition on this issue."
      16. From the above, it is evident that the appellant is entitled to
      economic adjustments in the circumstances of under capacity
      utilization of the company. Of course, such adjustments must be
                                       18         ITA No.3547, 5071/Del/2010


      restricted to fixed cost/overheads only. In the 14 instant case, the
      AO/TPO did not have the occasion to go into the period or the extent
      of the labour unrest, break-up of the claimed adjustments amounting
      Rs.7.32 crores '(rounded off), fixed cost versus the variable cost etc as
      they' summarily rejected the external comparables in view of their
      preference to the operating profits of the domestic segment of the
      carpets. ·Therefore and consequently, this key issue also has to be set
      aside to the files of the' TPO/AO for fresh examination of the issue."




      Prima facie we see the need for such economic adjustments to the
      total cost of the carpet of the export segment. We refuse to comment
      on the facts relating to the figures as none of the authorities has gone
      into the details of such economic adjustments and they summarily
      rejected the claims. As such, the requisite adjustments are borne out
      of the relevant rules/provisions and therefore, the claim is bona fide
      and has support of the law. For this,' the appellant prefers to go to the
      files of the AO for want of a speaking order on this issue. In our
      opinion, the request of the appellant deserves to' be considered
      favourable."

34.   Also, in the case of E.I. Dupont India Pvt. Ltd. vs. DCIT (ITA No
5336/0/2010), the Hon'ble Delhi Bench of the Tribunal, while allowing the
adjustment for capacity utilization held that ;
      "It is a matter of fact that fixed costs remain the same even when there
      is under utilization of capacity. Therefore, the case of the appellant
      and the comparable cases have to be examined in respect of capacity
      utilization so as to make the controlled and uncontrolled transactions
      comparable."
      Also, the Hon'ble Delhi Bench of the Tribunal in the case of ITO vs.
      CRM
      Services India Pvt. Ltd upheld the claim of the appellant towards
      adjustment of idle capacity:
      "8.1 This bring us to the alternative argument that the appellant is
      entitled to get adjustment in respect of capacity under-utilization. No
      objection has been raised by the Id. GIT, DR in this matter. As a
      matter of fact, he has fairly accepted the proposition that adjustment
      in this regard is-required to be made.
                                         19         ITA No.3547, 5071/Del/2010


         At the same time, it is a/so held that suitable adjustment has to be
         made to such PLI in respect of idle capacity."

35.      Further, the Hon'ble Bangalore bench of the Tribunal in the case of
Genisys Integrating Systems (India) Pvt. Ltd vs. DCIT (ITA No
1231/Bang/2010) the Hon'ble Tribunal held as under:
         "The appellant should also be given adjustment for under utilization
         of its infrastructure. The AO shall consider this fact also while
         determining the ALP find make the TP, adjustments. With these
         directions, the appeal of the appellant is disposed of. "

36.      Further, the Hon'ble Delhi' Bench of the Tribunal in the case of
Transwitch India Pvt. Ltd VS. ACIT (I.T.A. No. 6083/De1/2010) held as
under:
         "4.11 Another' TPO's contention is that claim of the appellant that the
         sealing drive reduced its revenue is unsubstantiated. In this regard,
         appellant has submitted that the appellant had placed on record its
         quarterly 'capacity' utilization statement demonstrating the fall in its
         capacity utilization during the quarter January to March, 2006. The
         capacity utilization, of the appellant during the quarter January to
         March, 2006 fell to i2% as' against the normal capacity utilization of
         87% to 94% during the financial year ending December, 31, 2005.
         Further, the fact that the appellant had to shift its office premises at a
         very short notice, sufficiently substantiates the low capacity utilization
         of the appellant during the last quarter of financial year 2005-06. We
         find out ourselves in agreement with the appellant's submission in this
         regard."

37.      Hon'ble Delhi High Court, in the appeal preferred by the revenue in
the case of Transwitch India (supra), vide order dated 17.07.2013, upheld the
adjustment claimed by the assessee on account of capacity utilization.
Reliance in this regard is also placed on the recent decision Delhi Bench of
the Tribunal in the case of DCIT vs. Panasonic AVC Networks India Co.
Ltd. (ITA No. 4620/0eI/2011), wherein the Hon'ble Bench has held that
                                      20          ITA No.3547, 5071/Del/2010


capacity underutilization is an important factor affecting net profit margin as
lower capacity utilization results in higher per unit costs which in turn
results in lower profits. The relevant finding of the decision reads as under:
      "5. Having heard the rival contentions and having perused the
      material on record, we see no reasons to interfere in very well
      reasoned findings and directions of the learned CIT (A). Rule 10B (1
      )(e)(ii) of the Income Tax Rules 1962 does indeed provide that the net
      profit margin realized in a comparable uncontrolled transaction is
      adjusted, inter alia, for differences in enterprise entering into such
      transactions, which could materially affect the net profit margin in
      open market. Capacity underutilization by enterprises is certainly 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 concerted, is
      reasonable accuracy embedded in the mechanism for such
      adjustments, 'end as long as such an adjustment mechanism can be
      found, no objection can be taken to the adjustment. In our considered
      view, the learned CIT(A)'s approach is reasonable in this regard and
      the adjustments are on a conceptually sound basis. In any case, as
      pointed out by the learned counsel, the adjustments so directed by the
      learned GIT(A) have duly been made by the Assessing Officer, and
      there have been no issues regarding implementing these adjustments.
      We approve the conclusions arrived by the CIT(A) on this issue and
      decline to interfere in the matter."

38.   In view of the aforesaid, it is respectfully submitted that appropriate
adjustment for idle capacity is required to be made while computing the
operating margin of the appellant.
39.   We have heard rival submissions and perused the material placed on
record. We find that there is force in the argument of Ld. Counsel for the
assessee that while calculating operating cost, the abnormal cost incurred on
account of start-up should be excluded.        Following the same parity of
reasoning in the cases cited by him and keeping in view that the judgement
                                          21         ITA No.3547, 5071/Del/2010


of ITAT co-ordinate Bench in the case of Transwitch India (supra) affirmed
by Hon'ble Delhi High Court. Therefore, respectfully following the decision
of Hon'ble High Court, we direct TPO / A.O. to adjust operating cost by
excluding abnormal cost incurred on account of start-up company like
salary, rent and depreciation. This matter is restored to the file of TPO/A.O.
to re-determine the operating cost on the above lines to arrive at operating
profit.
40.       The other grounds of appeal filed are not pressed and, therefore,
dismissed as such.
41.       The appeal is partly allowed for statistical purposes.
42.       Order pronounced in the open court on 10th July, 2015.


          Sd./-                                                Sd./-


 ( I. C. SUDHIR)                                   (INTURI RAMA RAO)
JUDICIAL MEMBER                                   ACCOUNTANT MEMBER
Date:10th July, 2015
Sp
Copy forwarded to:-
The appellant
The respondent
The CIT
The CIT (A)-, New Delhi.
The DR, ITAT, Loknayak Bhawan, Khan Market, New Delhi.
True copy.
                                            By Order


                                                  (ITAT, New Delhi).
                                                22              ITA No.3547, 5071/Del/2010




S.No.   Details                                      Date                  Initials   Designation
1       Draft dictated on                            26/6                             Sr. PS/PS
2       Draft placed before author                   29/6,1,3,6,7,8,9,9,              Sr. PS/PS
        Draft proposed & placed before the Second
3                                                                                     JM/AM
        Member
        Draft discussed/approved by Second
4                                                                                     AM/AM
        Member
5       Approved Draft comes to the Sr. PS/PS        10/07                            Sr. PS/PS
6       Kept for pronouncement                       10/07                            Sr. PS/PS
7       File sent to Bench Clerk                     10/07/15                         Sr. PS/PS
8       Date on which the file goes to Head Clerk
9       Date on which file goes to A.R.
10      Date of Dispatch of order

 
 
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