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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