DCIT, New Delhi V. M/s Class India Pvt. Ltd., New Delhi

ITA 1783/DEL/2011

• Counselvise Citation: [2015] 121 COUNSELVISE.COM (IT) 1735 (ITAT-DELHI)
• Duration Of Justice: 4 year(s) 3 month(s) 29 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 12-08-2015
• Appeal Filed By: Department
• Order Result: Partly Allowed
• Bench Allotted: I
• Next Hearing Date: 10-08-2015
• Assessment Year: 2005-2006
• Appeal Filed On: 13-04-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: Y KAKKAR; AMRENDRA KUMAR
• Keywords: Depreciation; Transfer pricing; International transaction; Capital expenditure
• Section: 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCHES : I : NEW DELHI BEFORE SHRI R.S. SYAL, AM AND SHRI A.T. VARKEY, JM ITA NO.1783/DEL/2011 ASSESSMENT YEAR : 2005-06 DCIT, CIRCLE-3(1), NEW DELHI. VS. CLAAS INDIA PVT. LTD., A-39, FIRST FLOOR, NEW FRIENDS COLONY, NEW DELHI. PAN: AAACE0762A CO NO.179/DEL/2011 (ITA NO.1783/DEL/2011) ASSESSMENT YEAR : 2005-06 CLAAS INDIA PVT. LTD., A-39, FIRST FLOOR, NEW FRIENDS COLONY, NEW DELHI. PAN: AAACE0762A VS. DCIT, CIRCLE-3(1), NEW DELHI (APPELLANT) (RESPONDENT) ASSESSEE BY : SHRI S.P. SINGH, CA, SHRI MANOMEET DALAL, ADVOCATE & SHRI VISHNU GOEL, ADVOCATE DEPARTMENT BY : SHRI AMRENDRA KUMAR, CIT, DR & MS Y. KAKKAR, SR.DR ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 2 DATE OF HEARING : 10.08.2015 DATE OF PRONOUNCEMENT : 12.08.2015 ORDER PER R.S. SYAL, AM: THIS APPEAL BY THE REVENUE AND THE CROSS OBJECTION BY THE ASSESSEE EMANATE FROM THE ORDER PASSED BY THE CIT(A ) ON 31.01.2011 IN RELATION TO THE ASSESSMENT YEAR 2005-06. 2. FIRST GROUND OF THE REVENUES APPEAL HAS TWO PAR TS. THE FIRST SEGMENT CHALLENGES THE INCLUSION OF TWO COMPANIES B Y THE LD. CIT(A) IN THE LIST OF COMPARABLES. THE ONLY ISSUE RAISED BY THE ASSESSEE IN ITS CROSS OBJECTION IS AGAINST THE AFFIRMATION OF INCLUSION O F ONE COMPANY IN THE LIST OF FINAL SET OF COMPARABLES. THE LD. AR DID N OT PRESS THE CROSS OBJECTION. AS SUCH, WE ARE CONFINED TO DECIDING O NLY AS TO WHETHER THE LD. CIT(A) WAS JUSTIFIED IN DIRECTING THE INCLUSION OF TWO COMPANIES IN THE FINAL SET OF COMPARABLES, NAMELY, M/S EICHER MO TORS AND M/S FORCE MOTORS. 3. BRIEFLY STATED, THE FACTS OF THE CASE ARE THAT T HE ASSESSEE WAS ESTABLISHED AS AN INDIAN COMPANY IN 1990 AS A WHOLL Y OWNED SUBSIDIARY ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 3 OF A CLAAS KGAA MBH, GERMANY. UNTIL 31.8.2002, THE ASSESSEE WAS KNOWN AS ESCORTS CLAAS LTD., WITH 60:40 JOINT VENTU RE BETWEEN ESCORTS INDIA LTD., AND CLAAS, GERMANY. THEREAFTER, THE EN TIRE SHAREHOLDING WAS ACQUIRED BY CLAAS, GERMANY. THE ASSESSEES MAIN ACT IVITY IS MANUFACTURE AND SALE OF HARVESTER COMBINES IN INDIA AND EXPORT OF HARVESTER COMBINES AND ENGINE HARVESTER COMBINES AN D ENGINE RELATED PRODUCTS, LICENSED BY CLAAS GROUP. THE ASSESSEE M ANUFACTURES TWO TYPES OF HARVESTER COMBINES, NAMELY, WHEEL BASED AN D TRACK BASED. CERTAIN INTERNATIONAL TRANSACTIONS WERE REPORTED BY THE ASSESSEE INCLUDING PURCHASE OF RAW MATERIALS; SALE OF HARVES TERS AND SPARES; PURCHASE OF COMPUTER; PAYMENT FOR ADMINISTRATIVE AN D SOFTWARE SUPPORT SERVICES; AND RECEIPT OF MARKET SUPPORT SERVICES. TO DEMONSTRATE THAT ITS INTERNATIONAL TRANSACTIONS WERE AT ARMS LENGTH PRI CE (ALP), THE ASSESSEE APPLIED THE TRANSACTIONAL NET MARGIN METHOD (TNMM) AS THE MOST APPROPRIATE METHOD WITH THE PROFIT LEVEL INDICATOR (PLI) OF OPERATING PROFIT/TOTAL COST (OP/TC). ALL THE INTERNATIONAL T RANSACTIONS WERE AGGREGATED AND A COMBINED OP/TC WAS COMPUTED. THE ASSESSEE CHOSE ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 4 THREE COMPANIES AS COMPARABLE, NAMELY, EICHER MOTOR S, FORCE MOTORS AND VST TRACTORS & TILLERS. THE ASSESSEE CLAIMED T HAT ITS ADJUSTED OP/TC WAS AT ARMS LENGTH. THE TPO INCLUDED M/S PU NJAB TRACTORS LTD. (SEGMENT), AS ONE OF THE COMPARABLES, AND EXCL UDED EICHER MOTORS AND FORCE MOTORS FROM THE LIST OF COMPARABLES DRAWN BY THE ASSESSEE. IN A NUTSHELL, THE TPO CONSIDERED TWO COMPANIES AS COMPARABLES, VIZ., VST TRACTORS & TILLERS AND PUNJAB TRACTORS LTD. (SE G.) WITH THEIR AVERAGE OP/TC AT 11.92%. THE ASSESSEE CHALLENGED T HE EXCLUSION OF EICHER MOTORS AND FORCE MOTORS BEFORE THE LD. CIT(A ) ALONG WITH THE INCLUSION BY THE TPO OF PUNJAB TRACTORS LTD. (SEG.) . THE LD. CIT(A) UPHELD THE INCLUSION OF PUNJAB TRACTORS LTD.(SEG.) AND ALSO DIRECTED TO INCLUDE EICHER MOTORS AND FORCE MOTORS IN THE FINAL SET OF COMPARABLES. THE REVENUE IS AGGRIEVED AGAINST THE INCLUSION OF E ICHER MOTORS AND FORCE MOTORS. SINCE THE ASSESSEE HAS NOT PRESSED I TS CROSS OBJECTION, THROUGH WHICH THE INCLUSION OF PUNJAB TRACTORS LTD. (SEG.) WAS ASSAILED, IT BECOMES MANIFEST THAT VST TRACTORS AND TILLERS A LONG WITH PUNJAB TRACTORS LTD., (SEG.) HAVE BEEN ACCEPTED BY THE ASS ESSEE AS PROPER ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 5 COMPARABLES. NOW, WE WILL DEAL WITH THE REVENUES CHALLENGE TO THE INCLUSION OF M/S EICHER MOTORS AND M/S FORCE MOTORS . M/S EICHER MOTORS 4.1. THE ASSESSEE INCLUDED THIS COMPANY IN THE LIST OF COMPARABLES. THE TPO OBSERVED THAT THE MOST OF THE SALES OF THIS COMPANY WERE OF TRACTORS. SINCE THE ASSESSEE WAS ENGAGED IN THE BU SINESS OF MANUFACTURING AND SELLING HARVESTER COMBINES, THE T PO HELD THIS COMPANY TO BE INCOMPARABLE. THE LD. CIT(A) NOTICED THAT THE ASSESSEE WAS FOLLOWING TNMM AS THE MOST APPROPRIATE METHOD. SINCE THE HARVESTER COMBINES FALL WITHIN THE OVERALL CATEGORY OF AGRICULTURAL EQUIPMENTS, THE LD. CIT(A) HELD THIS COMPANY AS COM PARABLE. THE REVENUE IS AGGRIEVED AGAINST THE INCLUSION OF THIS COMPANY IN THE FINAL LIST OF COMPARABLES DRAWN BY THE LD. FIRST APPELLAT E AUTHORITY. 4.2. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUS ED THE RELEVANT MATERIAL ON RECORD. THERE IS NO DISPUTE ON THE FAC T THAT THE ASSESSEE IS FOLLOWING THE TNMM AS THE MOST APPROPRIATE METHOD. IT IS ALSO ADMITTED THAT THE ASSESSEE DEALS IN HARVESTER COMBI NES AND NOT TRACTORS. ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 6 IT IS EQUALLY UNOPPOSED THAT EICHER MOTORS IS ENGAG ED IN THE BUSINESS OF MANUFACTURE AND SALE OF TRACTORS AND NOT HARVESTER COMBINES. THE QUESTION ARISES AS TO WHETHER EICHER MOTORS, MANUFA CTURING TRACTORS CAN BE CONSIDERED AS A GOOD COMPARABLE OF THE ASSESSEE, MANUFACTURING HARVESTER COMBINES. THE FIRST AND THE FOREMOST PARA METER FOR TESTING THE COMPARABILITY OF A COMPANY IS ITS FUNCTIONAL SIMILA RITY. OTHER FACTORS FOLLOW LATER ON. FUNCTIONAL SIMILARITY IS SINE QUA NON FOR ANY COMPARABILITY ANALYSIS. THE DEGREE OF FUNCTIONAL S IMILARITY MAY VARY DEPENDING UPON THE METHOD OF DETERMINING ARMS LENG TH PRICE (ALP). WHEREAS THE COMPARABLE UNCONTROLLED METHOD (CUP) DE MANDS THE SCALE OF SIMILARITY OF A HIGHEST ORDER, THE SAME CAN BE C OMPROMISED TO SOME EXTENT UNDER THE TNMM. COMPROMISING SIMILARITY TO SOME EXTENT UNDER THE TNMM DOES NOT MEAN SWITCHING OVER TO AN ALTOGET HER DIFFERENT PRODUCT. A COMPARISON EVEN UNDER THE TNMM IS CONTEM PLATED WITH A COMPARABLE UNCONTROLLED TRANSACTION. UNLESS A COMPANY IS FUNCTIONALLY SIMILAR, THERE CAN BE NO QUESTION OF T REATING IT AS A PROBABLE COMPARABLE IN THE FIRST INSTANCE FOR FURTHER EVALUA TION. ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 7 4.3. ADVERTING TO THE FACTS OF THE INSTANT CASE, WE FIND THAT THE LD. CIT(A) HAS HELD A TRACTOR MANUFACTURER AS COMPARABL E WITH A HARVESTER COMBINE MANUFACTURER. WHEREAS A HARVESTER COMBINE I S A MACHINE THAT HARVESTS GREEN CROPS BY COMBINING THREE SEPARATE OP ERATIONS, NAMELY, REAPING, THRESHING AND WINNOWING, A TRACTOR IS A VE HICLE USED FOR DRAWING OR PULLING. FURTHER, A COMBINE IS SEVERAL TIMES DEA RER THAN A TRACTOR. IT CAN BE OBSERVED THAT THE FUNCTIONS OF BOTH, ALONG W ITH THEIR RESPECTIVE PRICE TAGS, ARE ENTIRELY DIFFERENT FROM EACH OTHER. IT IS BEYOND OUR COMPREHENSION AS TO HOW A MANUFACTURER OF A TRACTOR CAN BE CONSIDERED AS COMPARABLE WITH THE MANUFACTURER OF HARVESTER CO MBINE. SIMPLY BECAUSE BOTH THE MACHINES FALL IN THE OVERALL CATEG ORY OF `AGRICULTURAL EQUIPMENTS, IT DOES NOT MEAN THAT THEY BECOME COMP ARABLE TO EACH OTHER. IF ONE ACCEPTS SUCH A LOGIC AS APPLIED BY T HE LD. CIT(A), THEN THE MANUFACTURER OF OTHER AGRICULTURAL EQUIPMENTS, SUCH AS TILLERS, WOULD ALSO BECOME COMPARABLE WITH A MANUFACTURER OF TRACTOR OR HARVESTER COMBINE AND VICE VERSA , WHICH PROPOSITION IS ABSOLUTELY ABSURD. IN VIEW OF THE INHERENT DIFFERENCES IN THE CHARACTERISTICS, USAGE AND PRICE OF HARVESTER ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 8 COMBINE AND TRACTORS, WE ARE UNABLE TO COUNTENANCE THE VIEW TAKEN BY THE LD. CIT(A) IN TREATING M/S EICHER MOTORS AS A GOOD COMPARABLE. THE IMPUGNED ORDER ON THIS SCORE IS OVERTURNED AND THE VIEW OF THE TPO IS RESTORED. M/S FORCE MOTORS 5. THE FACTS AND CIRCUMSTANCES OF M/S FORCE MOTORS ARE MUTATIS MUTANDIS SIMILAR TO THOSE OF M/S EICHER MOTORS. THIS COMPA NY, INITIALLY CONSIDERED AS COMPARABLE BY THE ASSESSEE, WAS ALSO EXCLUDED BY THE TPO ON THE SAME REASONING AS GIVEN FOR M/S EICHER M OTORS AND THE LD. CIT(A) ALSO UPHELD THE INCLUSION OF THIS COMPANY IN THE LIST OF COMPARABLES BY FOLLOWING THE SAME REASONING AS GIVE N BY HIM FOR M/S EICHER MOTORS. IN VIEW OF OUR ABOVE DISCUSSION MADE IN THE CONTEXT OF M/S EICHER MOTORS, WE HOLD THAT M/S FORCE MOTORS CA NNOT BE CONSIDERED AS A GOOD COMPARABLE. THE IMPUGNED ORDER ON THIS S CORE IS REVERSED. ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 9 CAPACITY UTILIZATION ADJUSTMENT 6. THE SECOND SEGMENT OF GROUND NO. 1 OF THE REVENU ES APPEAL IS AGAINST THE ALLOWING OF CAPACITY ADJUSTMENT IN RESP ECT OF CERTAIN ITEMS OF EXPENSES, WHICH WAS DENIED BY THE TPO. 7. THE FACTS APROPOS THIS ISSUE ARE THAT THE ASSESS EE CLAIMED TO HAVE WORKED AT A CAPACITY OF 29% DURING THE YEAR IN QUES TION. IT WAS FURTHER CLAIMED THAT THE THREE COMPARABLES CHOSEN BY IT WOR KED AT THE AVERAGE CAPACITY UTILIZATION OF 44%. THAT IS HOW, THE ASSE SSEE CLAIMED CAPACITY UTILIZATION ADJUSTMENT BY REDUCING ITS OPERATING CO STS ACCORDINGLY. IN SUPPORT OF DEDUCTION, THE ASSESSEE FILED A REPORT O F MR. CHANDRA WADHVA, A COST ACCOUNTANT. AS PER THIS REPORT, THE CAPACITY UTILIZATION OF THE ASSESSEE AS WELL AS THE COMPARABLES WAS INI TIALLY RAISED TO 100%. THE TPO PARTLY ACCEPTED THE CLAIM OF THE ASSESSEE. HE CONSIDERED VST TRACTORS AND TILLERS AND PUNJAB TRACTORS LTD. (SEG. ) FOR THE PURPOSES OF ALLOWING CAPACITY ADJUSTMENT WITH AN AVERAGE CAPACI TY UTILIZATION TAKEN AT 54%. THEREAFTER, HE RESTRICTED THE REDUCTION IN OPERATING COSTS OF THE ASSESSEE DUE TO CAPACITY UTILIZATION, TO SOME ADMIN ISTRATIVE COSTS AND ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 10 OTHER EXPENSES. AS AGAINST THE ASSESSEES ACTUAL DE DUCTION OF RS.6,65,79,916 FOR SUCH SELECTIVE ITEMS OF ADMINIST RATIVE AND OTHER EXPENSES, THE TPO ADJUSTED SUCH COSTS TO RS.6,30,30 ,739 BY APPLYING THE FACTOR OF 29/54 (29%, BEING, THE ASSESSEES CAPACI TY UTILIZATION AND 54%, BEING, THE AVERAGE CAPACITY UTILIZATION OF COM PARABLES CHOSEN BY HIM). SIMILARLY, HE REDUCED THE AMOUNT OF DEPRECIA TION CLAIMED BY THE ASSESSEE AT RS.1,19,60,921 TO RS.64,23,458 BY APPLY ING THE SAME FACTOR OF 29/54. AFTER ALLOWING THIS CAPACITY UTILIZATION ADJUSTMENT, HE DETERMINED OP/TC OF THE ASSESSEE AT A LOSS OF (-) 7 .78%. TOTAL COST OF THE ASSESSEE WAS TAKEN AT RS.36.88 CRORE. BY APPLY ING THE ARITHMETIC MEAN OF THE PROFIT RATE OF COMPARABLE COMPANIES CHO SEN BY HIM AT 11.92%, HE PROPOSED A TRANSFER PRICING ADJUSTMENT O F RS.7,26,60,103/-, FOR WHICH ADDITION WAS MADE BY THE AO. THE LD. CIT( A) ACCEPTED THE ASSESSEES CONTENTION ABOUT NOT MAKING ANY TP ADJU STMENT IN RELATION TO NON-AE TRANSACTIONS. THE REVENUE IS NOT AGGRIEVED TO THAT EXTENT. AS REGARDS ADJUSTMENT FOR CAPACITY UTILIZATION, THE LD . CIT(A), BY CONSIDERING THE COMPANIES FINALLY HELD BY HIM AS CO MPARABLE, APPLIED ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 11 THE FACTOR OF 29/46 FOR REDUCING THE OPERATING COST S ACTUALLY INCURRED BY THE ASSESSEE. APART FROM THE ADJUSTMENTS ALLOWED B Y THE TPO ON ADMINISTRATION EXPENSES AND DEPRECIATION, THE LD. C IT(A) ALSO REDUCED ADVERTISEMENT & MARKETING EXPENSES, EMPLOYEE COST ( BY TAKING ENTIRE EMPLOYEE COST, OTHER THAN BONUS, AT RS.35515709 AS FIXED). THE REVENUE IS AGGRIEVED AGAINST THE ALLOWING OF CAPACITY UTILI ZATION ADJUSTMENT TO THIS EXTENT BY THE LD. CIT(A). 8. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUS ED THE RELEVANT MATERIAL ON RECORD. BEFORE EMBARKING UPON THE QUEST ION OF ALLOWABILITY AND EXTENT OF CAPACITY ADJUSTMENT UNDER THE TNMM, WE WANT TO MAKE IT CLEAR THAT THE ASSESSEE REDUCED ITS OPERATING CO STS BY CONSIDERING ITS CAPACITY UTILIZATION VIS--VIS THAT OF COMPARABLES AND RESULTANTLY CLAIMED THAT ITS INCREASED PROFIT AS A RESULT OF SUCH REDUC ED OPERATING COSTS BE COMPARED WITH THAT OF THE COMPARABLES. THE TPO HAS ALSO AGREED IN PRINCIPLE WITH THE OTHERWISE AVAILABILITY OF THE CA PACITY ADJUSTMENT. THE ISSUE OF ALLOWING CAPACITY ADJUSTMENT BEFORE US CAN BE DIVIDED INTO TWO SUB-ISSUES FOR CONSIDERATION, VIZ., FIRST, WHETHER THE ADJUSTMENT SHOULD BE ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 12 ALLOWED IN THE HANDS OF THE ASSESSEE AS HAS BEEN DO NE BY THE AUTHORITIES BELOW OR COMPARABLES AND SECOND, HOW TO COMPUTE CA PACITY UTILIZATION ADJUSTMENT UNDER THE TNMM. WE WILL DEAL WITH THESE ASPECTS ONE BY ONE. I. CAPACITY ADJUSTMENT SHOULD BE ALLOWED IN WHOSE HANDS ? 9.1. IT HAS BEEN NOTICED ABOVE THAT THE ASSESSEE CLAIMED IDLE CAPACITY ADJUSTMENT BY REDUCING ITS OWN OPERATING COSTS. IT IS FURTHER OBSERVED THAT THE AUTHORITIES BELOW HAVE REDUCED THE AMOUNT OF ADJUSTMENT BY EXCLUDING CERTAIN COSTS FROM THE AMBIT OF THE COSTS QUALIFYING FOR ADJUSTMENT. HOWEVER, THE ADJUSTMENT HAS BEEN ULTIMA TELY ALLOWED FROM THE OPERATING COSTS INCURRED BY THE ASSESSEE. IN SU CH CIRCUMSTANCES, THE QUESTION ARISES AS TO WHETHER THE ACTION OF THE AUT HORITIES IN ALLOWING THE REDUCTION OF THE OPERATING COSTS INCURRED BY THE AS SESSEE, IS IN ACCORDANCE WITH LAW? IN ORDER TO FIND ANSWER TO THI S QUESTION, WE NEED TO REFER TO THE MANNER OF COMPUTATION OF THE ARMS LENGTH PRICE UNDER TNMM, WHICH HAS BEEN SET OUT IN RULE 10B(1)(E) AS U NDER:- (E) TRANSACTIONAL NET MARGIN METHOD, BY WHICH, ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 13 (I) THE NET PROFIT MARGIN REALISED BY THE ENTERPRIS E FROM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH AN A SSOCIATED ENTERPRISE IS COMPUTED IN RELATION TO COSTS INCURRE D OR SALES EFFECTED OR ASSETS EMPLOYED OR TO BE EMPLOYED BY TH E ENTERPRISE OR HAVING REGARD TO ANY OTHER RELEVANT B ASE ; (II) THE NET PROFIT MARGIN REALISED BY THE ENTERPRI SE OR BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROL LED 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-CLAU SE (II) ARISING IN COMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES, IF ANY, BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONT ROLLED TRANSACTIONS, OR BETWEEN THE ENTERPRISES ENTERING I NTO SUCH TRANSACTIONS, WHICH COULD MATERIALLY AFFECT THE AMO UNT OF NET PROFIT MARGIN IN THE OPEN MARKET ; (IV) THE NET PROFIT MARGIN REALISED BY THE ENTERPRI SE AND 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 TAKEN INTO ACCOUNT TO ARRIVE AT AN ARMS LENGTH PRICE IN RELATION TO THE INTERNATIONAL TRANSACTION. 9.2. SUB-CLAUSE (I) IN THE PROCESS OF DETERMINATI ON OF THE ALP UNDER THE TNMM TALKS OF THE COMPUTATION OF NET OPERATING PROFIT MARGIN REALIZED BY THE ASSESSEE FROM AN INTERNATIONAL TRAN SACTION. SUB-CLAUSE (II) IS THE COMPUTATION OF NET OPERATING PROFIT MAR GIN REALIZED BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED TRANSACTION. THIS ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 14 REFERS TO DETERMINING THE OPERATING PROFIT MARGIN O F COMPARABLES WITH THE SAME BASE AS THAT OF THE ASSESSEE. SUB-CLAUSE ( III) PROVIDES THAT THE NET PROFIT MARGIN REALIZED BY A COMPARABLE COMPANY , DETERMINED AS PER SUB-CLAUSE (II) ABOVE, IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES, I F ANY, BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS, ..... WHICH COULD MATERI ALLY AFFECT THE AMOUNT OF NET PROFIT MARGIN IN THE OPEN MARKET. IT IS THIS ADJUSTED NET PROF IT MARGIN OF THE UNRELATED TRANSACTIONS OR OF THE COMP ARABLE COMPANIES, AS DETERMINED UNDER SUB-CLAUSE (III), WHICH IS USED FO R THE PURPOSES OF MAKING COMPARISON WITH THE NET PROFIT MARGIN REALIZ ED BY THE ASSESSEE FROM ITS INTERNATIONAL TRANSACTION AS PER SUB-CLAUS E (I). 9.3. SUB-RULE (2) OF RULE 10B PROVIDES THAT THE CO MPARABILITY OF AN INTERNATIONAL TRANSACTION WITH AN UNCONTROLLED TRAN SACTION SHALL BE JUDGED WITH REFERENCE TO CERTAIN FACTORS WHICH HAVE BEEN E NUMERATED THEREIN. RULE 10B(3) STATES THAT AN UNCONTROLLED TRANSACTION SHALL BE COMPARABLE TO AN INTERNATIONAL TRANSACTION, IF EITHER THERE AR E NO DIFFERENCES BETWEEN THE TWO OR A REASONABLY ACCURATE ADJUSTMENT CAN BE MADE TO ELIMI NATE ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 15 THE MATERIAL EFFECTS OF SUCH DIFFERENCES. WHEN WE READ SUB-CLAUSES (II) & (III) OF RULE 10B(1)(E) IN JUXTAPOSITION TO SUB- RULES (2) & (3) OF RULE 10B, THE POSITION WHICH EMERGES IS THAT THE NET OPE RATING PROFIT MARGIN OF COMPARABLE COMPANIES CALLS FOR ADJUSTMENT IN SU CH A MANNER SO AS TO BRING BOTH THE INTERNATIONAL TRANSACTION AND COMPAR ABLE CASES AT THE SAME PEDESTAL. IN OTHER WORDS, IF THERE ARE NO DIFF ERENCES IN THESE TWO, THEN THE AVERAGE OF THE NET OPERATING PROFIT MARGIN OF THE COMPARABLE COMPANIES BECOMES A BENCHMARK. HOWEVER, IN CASE THE RE ARE SOME DIFFERENCES BETWEEN THE COMPARABLES AND THE ASSESSE E, THEN THE EFFECT OF SUCH DIFFERENCES SHOULD BE IRONED OUT BY MAKING SUI TABLE ADJUSTMENT TO THE OPERATING PROFIT MARGIN OF COMPARABLES. THAT IS THE WAY FOR BRINGING BOTH THE TRANSACTIONS, NAMELY, THE INTERNATIONAL TR ANSACTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS, ON THE SAME P LATFORM FOR MAKING A MEANINGFUL AND EFFECTIVE COMPARISON. THE ABOVE AN ALYSIS OVERTLY TRANSPIRES THAT THE LAW PROVIDES FOR ADJUSTING THE PROFIT MARGIN OF COMPARABLES ON ACCOUNT OF THE MATERIAL DIFFERENCES BETWEEN THE INTERNATIONAL TRANSACTION OF THE ASSESSEE AND COMPA RABLE UNCONTROLLED ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 16 TRANSACTIONS. IT IS NOT THE OTHER WAY AROUND TO ADJ UST THE PROFIT MARGIN OF THE ASSESSEE. IN OTHER WORDS, THE NET OPERATING PR OFIT MARGIN REALIZED BY THE ASSESSEE FROM ITS INTERNATIONAL TRANSACTION IS TO BE COMPUTED AS SUCH, WITHOUT ADJUSTING IT ON ACCOUNT OF DIFFERENCES WITH THE COMPARABLE UNCONTROLLED TRANSACTIONS. THE ADJUSTMENT, IF ANY, IS REQUIRED TO BE MADE ONLY IN THE PROFIT MARGINS OF THE COMPARABLES. 9.4. REVERTING TO THE FACTS OF THE INSTANT CASE , WE FIND THAT THE AUTHORITIES BELOW HAVE ADJUSTED THE OPERATING COSTS OF THE ASSESSEE IN ALLOWING THE CAPACITY ADJUSTMENT. AS AGAINST THAT, THE CORRECT COURSE OF ACTION PROVIDED UNDER THE LAW IS TO ADJUST THE OPER ATING COSTS OF THE COMPARABLE AND THEIR RESULTANT OPERATING PROFIT. T HERE IS HARDLY NEED TO ACCENTUATE THAT THERE CAN BE NO ESTOPPEL AGAINST TH E LAW. ONCE THE LAW ENJOINS FOR DOING A PARTICULAR THING IN A PARTICULA R MANNER ALONE, IT IS NOT OPEN TO ANYONE TO ADOPT A CONTRARY OR DIFFERENT APP ROACH. AS THE AUTHORITIES BELOW HAVE ADOPTED A COURSE OF ACTION I N ALLOWING ADJUSTMENT, WHICH IS NOT IN CONSONANCE WITH LAW, WE CANNOT APPROVE THE SAME. THE IMPUGNED ORDER IS SET ASIDE AND THE MATTE R IS RESTORED TO THE ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 17 FILE OF THE TPO/AO FOR GIVING EFFECT TO THE AMOUNT OF IDLE CAPACITY ADJUSTMENT IN THE OPERATING PROFIT OF THE COMPARABL ES AND NOT THE ASSESSEE. II. HOW TO COMPUTE CAPACITY UTILIZATION ADJUSTMENT UNDER TNMM : - 10.1. UNDER THE TNMM, THE ALP OF AN INTERNATIONAL TRANSACTION IS DETERMINED BY COMPUTING AND COMPARING THE PERCENTAG E OF OPERATING PROFIT MARGIN REALIZED BY THE ASSESSEE WITH THAT OF THE COMPARABLES. WE HAVE NOTICED ABOVE THAT THE DIFFERENCE IN THE CAPAC ITY UTILIZATIONS IS AN IMPORTANT FACTOR, WHICH NEEDS TO BE ADJUSTED. NO ME CHANISM HAS BEEN GIVEN UNDER THE ACT OR THE RULES FOR COMPUTING THE AMOUNT OF CAPACITY UTILIZATION ADJUSTMENT. 10.2. ON AN OVERALL UNDERSTANDING, WE FEEL THAT UNDER THE TNMM, THE FIRST STEP IN GRANTING CAPACITY UTILIZATION ADJUSTM ENT IS TO ASCERTAIN THE PERCENTAGE OF CAPACITY UTILIZATION BY THE ASSESSEE AND COMPARABLES. THERE CAN BE NO DIFFICULTY IN WORKING OUT THESE PER CENTAGES. THE SECOND STEP IS TO GIVE EFFECT (POSITIVE OR NEGATIVE) TO TH E DIFFERENCE IN THE PERCENTAGE OF CAPACITY UTILIZATIONS OF THE ASSESSEE VIS--VIS COMPARABLES, ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 18 ONE BY ONE, IN THE OPERATING PROFIT OF COMPARABLES BY ADJUSTING THEIR RESPECTIVE OPERATING COSTS. OPERATING COSTS CAN BE EITHER FIXED OR VARIABLE OR SEMI-VARIABLE. ONE NEEDS TO SPLIT SEMI- VARIABLE COSTS INTO THE FIXED PART AND VARIABLE PART. IN SO FAR AS THE VARI ABLE COSTS AND THE VARIABLE PART OF THE SEMI-VARIABLE COSTS ARE CONCER NED, THESE REMAIN UNAFFECTED DUE TO ANY UNDER OR OVER UTILIZATION OF CAPACITY. ACCORDINGLY, SUCH VARIABLE OPERATING COSTS REMAIN UNCHANGED. THE ADJUSTMENT IS CALLED FOR ONLY IN RESPECT OF THE FIXED OPERATING C OSTS AND FIXED PART OF SEMI-VARIABLE COSTS. SUCH COSTS ARE SCALED UP OR DO WN BY CONSIDERING THE PERCENTAGE OF CAPACITY UTILIZATION BY THE ASSESSEE AND SUCH COMPARABLE. IT CAN BE ILLUSTRATED WITH THE HELP OF A SIMPLE EXA MPLE. SUPPOSE THE FIXED COSTS INCURRED BY A COMPARABLE (SAY, A) ARE RS. 10 0 AND IT HAS CAPACITY UTILIZATION OF 50% AS AGAINST THE CAPACITY UTILIZAT ION OF 25% BY THE ASSESSEE. THE ABOVE PERCENTAGES SHOW THAT THE ASSES SEE HAS INCURRED FULL FIXED COSTS WITH 25% OF THE UTILIZATION OF ITS CAPA CITY, AS AGAINST A INCURRING FULL FIXED COSTS WITH 50% OF ITS CAPACITY UTILIZATION. THIS DIVULGES THAT THE ASSESSEE HAS INCURRED RELATIVELY MORE FIXED COSTS AND A ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 19 HAS INCURRED LOWER COSTS. IN ORDER TO MAKE AN EFFEC TIVE COMPARISON, THERE ARISES A NEED TO OBLITERATE THE EFFECT OF THIS DIFF ERENCE IN CAPACITY UTILIZATIONS. IT CAN BE DONE BY PROPORTIONATELY SCA LING UP THE FIXED COSTS INCURRED BY A SO AS TO MAKE IT FULLY COMPARABLE WIT H THE ASSESSEE. THIS WE CAN DO BY INCREASING THE FIXED COSTS OF A TO RS. 200 (RS.100 INTO 50/25) AS AGAINST THE ACTUALLY INCURRED FIXED COST S BY IT AT RS.100. WHEN WE COMPUTE OPERATING PROFIT OF A BY SUBSTITUTING TH E FIXED COSTS AT RS.200 WITH THE ACTUALLY INCURRED AT RS.100, IT WOU LD MEAN THAT THE FIXED COSTS INCURRED BY THE ASSESSEE AND A ARE AT THE SAM E CAPACITY UTILIZATION. THERE CAN BE CONVERSE SITUATION AS WELL. SUPPOSE TH E FIXED COSTS INCURRED BY A COMPARABLE (SAY, B) ARE RS. 100 AND IT HAS CA PACITY UTILIZATION OF 25% AS AGAINST THE CAPACITY UTILIZATION OF 50% BY T HE ASSESSEE. THE ABOVE PERCENTAGES SHOW THAT THE ASSESSEE HAS INCURR ED FULL FIXED COSTS AT 50% OF THE UTILIZATION OF ITS CAPACITY, AS AGAINST B INCURRING FULL FIXED COSTS AT 25% OF THE CAPACITY UTILIZATION. THIS DECI PHERS THAT THE ASSESSEE HAS INCURRED RELATIVELY LOWER FIXED COSTS AND B HAS INCURRED HIGHER COSTS. THIS DIFFERENCE IN CAPACITY UTILIZATIONS CAN BE ELI MINATED BY ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 20 PROPORTIONATELY SCALING DOWN THE FIXED COSTS INCURR ED BY B SO AS TO MAKE IT FULLY COMPARABLE. THIS WE CAN DO BY REDUCING TH E FIXED COSTS OF B TO RS. 50 (RS.100 INTO 25/50) AS AGAINST THE ACTUALLY INCURRED FIXED COST BY IT AT RS.100. WHEN WE COMPUTE OPERATING PROFIT OF B BY SUBSTITUTING THE FIXED COSTS AT RS.50 WITH THE ACTUALLY INCURRED AT RS.100, IT WOULD MEAN THAT THE FIXED COSTS INCURRED BY THE ASSESSEE AND B ARE AT THE SAME CAPACITY UTILIZATION LEVEL. 10.3. TURNING TO THE FACTS OF THE INSTANT CASE, WE FIND THAT BOTH THE TPO AS WELL AS THE LD. CIT(A) HAVE PROCEEDED ON A WRONG PREMISE NOT ONLY BY ALLOWING CAPACITY UTILIZATION ADJUSTMENT IN THE ASSESSEES PROFIT, WHICH IS CONTRARY TO THE LEGAL POSITION AS DISCUSSE D ABOVE, BUT ALSO BY CONSIDERING ALL THE COMPARABLES AS ONE UNIT WITH TH E AVERAGE PERCENTAGE OF THEIR RESPECTIVE CAPACITY UTILIZATIONS. IT IS F URTHER OBSERVED THAT IN THE CALCULATION OF SUCH CAPACITY UTILIZATION ADJUSTMENT , THE LD. CIT(A) HAS CONSIDERED FOUR COMPANIES AS COMPARABLE, WHICH VIEW HAS BEEN MODIFIED BY US SUPRA INASMUCH AS WE HAVE HELD THAT M/S EICHER MOTORS AND M/S. FORCE MOTORS ARE INCOMPARABLE. NATURALLY, THEY WOULD ALSO GO ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 21 OUT OF RECKONING IN THE COMPUTATION OF IDLE CAPACIT Y UTILIZATION ADJUSTMENT. IN THE ABSENCE OF THE AVAILABILITY OF FINANCIALS OF ALL THE COMPARABLE COMPANIES, IT IS NOT POSSIBLE AT OUR END TO WORK OUT THE AMOUNT OF CAPACITY ADJUSTMENT IN THE MANNER DISCUSS ED ABOVE. ERGO, WE SET ASIDE THE IMPUGNED ORDER AND DIRECT THE TPO/AO TO WORK OUT THE AMOUNT OF CAPACITY UTILIZATION ADJUSTMENT AFRESH IN TERMS OF OUR ABOVE OBSERVATIONS. NEEDLESS TO SAY, THE ASSESSEE WILL BE ALLOWED A REASONABLE OPPORTUNITY OF HEARING IN SUCH FRESH PROCEEDINGS. 11.1. GROUND NO. 2 IS AGAINST THE DELETION OF ADDI TION OF RS.61,762/- ON ACCOUNT OF CAPITALIZATION OF SOFTWARE EXPENSES. SU CCINCTLY, THE FACTS OF THIS GROUND ARE THAT THE ASSESSEE CLAIMED DEDUCTION AMOUNTING TO RS.27,97,008/- TOWARDS SOFTWARE EXPENSES. ON PERUS AL OF DETAILS OF SUCH EXPENSES, IT WAS OBSERVED BY THE AO THAT A SUM OF R S.1,49,611/- WAS SPENT AS SUBSCRIPTION FOR ANTI-VIRUS SOFTWARE, RS. 2,895/- FOR WEBSITE CHARGES AND RS.1,900/- TOWARDS PURCHASE OF MODEM. THE AO CAPITALIZED THESE THREE ITEMS WITH A TOTAL OF RS.1, 54,406/- AND ALLOWED DEPRECIATION AS APPLICABLE TO COMPUTERS ON SUCH AMO UNT @ 60%. THIS ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 22 LED TO THE MAKING OF ADDITION OF RS.61,762/-. THE LD. CIT(A) DELETED THE ADDITION. 11.2. AFTER CONSIDERING THE RIVAL SUBMISSIONS AN D PERUSING THE RELEVANT MATERIAL ON RECORD, WE FIND THAT THE FIRST ITEM IS ANTI-VIRUS SOFTWARE SUBSCRIPTION FOR WHICH A SUM OF RS.1,49,611/- WAS P AID BY THE ASSESSEE. ON BEING CALLED UPON TO PRODUCE THE BILL FOR THIS S OFTWARE SUBSCRIPTION, THE LD. AR EXPRESSED HIS INABILITY AS THE SAME WAS NOT READILY AVAILABLE. THE EXTENT OF DEDUCTIBILITY OF THIS AMOUNT DEPENDS UPON THE PERIOD FOR WHICH THIS SUBSCRIPTION AND FROM THE DATE ON WHICH IT WAS PAID. IF IT IS GIVEN FOR A PERIOD OF MORE THAN ONE YEAR, THEN NATU RALLY, THE AMOUNT RELATABLE TO THE PERIOD BEYOND THE FIRST YEAR, WOUL D NOT BE ADMISSIBLE FOR DEDUCTION DURING THE YEAR IN QUESTION. IF THE AMOUN T IS PAID FOR ONE YEAR, THEN THE SUBSCRIPTION PERIOD COVERED DURING THE YEA R WILL BE DEDUCTIBLE AND THE REMAINING AMOUNT WILL QUALIFY FOR DEDUCTION IN THE SUCCEEDING YEAR. IN THE ABSENCE OF THE AVAILABILITY OF THE DAT E AND THE PERIOD OF SUBSCRIPTION PERIOD, WE SET ASIDE THE IMPUGNED ORDE R ON THIS ISSUE AND ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 23 SEND THE MATTER TO THE AO FOR DECIDING IT IN CONFOR MITY WITH OUR ABOVE OBSERVATIONS. 11.3. COMING TO THE WEBSITE CHARGES OF RS.2,895/- , WE FIND THAT THE CREATION OF WEBSITE IS AN ADVANTAGE WHICH FACILITI ES CARRYING ON BUSINESS MORE EFFICIENTLY AND PROFITABLY LEAVING FIXED CAPIT AL UNTOUCHED. THE HONBLE SUPREME COURT IN EMPIRE JUTE COMPANY LIMITED VS. CIT (1980) 124 ITR 1 (SC) HAS HELD THAT SUCH EXPENSES SHOULD BE CONSIDERED AS REVENUE IN NATURE. THE MUMBAI BENCH OF THE TRIBU NAL VIDE ITS ORDER DATED 9.2.2011 IN ADDL. CIT VS. AVENDUS ADVISORS PVT. LTD. (ITA NO. 5860/MUM/2008 & 2712/MUM/2009) HAS HELD THAT WEBSIT E DEVELOPMENT CHARGES ARE REVENUE IN NATURE. RESPECTFULLY FOLLOWI NG THE PRECEDENT, WE UPHOLD THE IMPUGNED ORDER TO THIS EXTENT. 11.4. THE THIRD AMOUNT IS PRICE OF MODEM. IN OU R CONSIDERED OPINION, THE SAME IS A CAPITAL EXPENDITURE ELIGIBLE FOR DEPR ECIATION @ 60% AS APPLICABLE TO COMPUTER. OUR VIEW IS FORTIFIED BY TH E JUDGMENT OF THE HONBLE DELHI HIGH COURT IN CIT VS. BSES YAMUNA POWERS LTD. 2010 TIOL-636-HC-DEL-IT AND THAT OF THE SPECIAL BENCH OF THE TRIBUNAL IN ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 24 DCIT VS. DATACRAFT INDIA LTD. (2010) 133 TTJ (MUMBA I)(SB) 377 . THE IMPUGNED ORDER IS REVERSED AND THE ACTION OF THE AO IS RESTORED TO THIS EXTENT. THIS GROUND IS DISPOSED OF ACCORDINGLY. 12.1. GROUND NO. 3 IS AGAINST THE DELETION OF ADDI TION OF RS.37,03,000/- ON ACCOUNT OF DEFERRED REVENUE EXPEN DITURE. THE FACTUAL MATRIX OF THIS GROUND IS THAT THE ASSESSEE CAPITAL IZED CERTAIN SUM FOR DEVELOPMENT OF A NEW PRODUCT CALLED TAF60. TILL 30 .9.2003, A SUM OF RS.156 LAC WAS CAPITALIZED AND TREATED AS CAPITAL W ORK-IN-PROGRESS. A FURTHER SUM OF RS.28.32 LAC WAS INCURRED ON ITS DEV ELOPMENT BETWEEN 1.10.2003 TO 31.3.2004. THE ASSESSEE CAPITALIZED TH E ENTIRE SUM AND CLAIMED DEDUCTION @ 25% OF THE SAME IN THE EARLIER YEARS AND IN THE YEAR IN QUESTION. THE AO TREATED THIS AMOUNT AS CA PITAL EXPENDITURE AND DID NOT ALLOW ANY DEDUCTION. THE LD. CIT(A) ACCEPT ED THE ASSESSEES CLAIM. 12.2. AFTER CONSIDERING THE RIVAL SUBMISSIONS AND PERUSING THE RELEVANT MATERIAL ON RECORD, WE FIND THAT SIMILAR I SSUE CAME UP FOR CONSIDERATION BEFORE THE TRIBUNAL IN THE ASSESSEES OWN CASE FOR THE AY ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 25 2007-08. A COPY OF SUCH ORDER HAS BEEN PLACED ON R ECORD IN WHICH THIS ISSUE HAS BEEN DECIDED IN THE ASSESSEES FAVOUR. I N THE ABSENCE OF THE LD. DR BRINGING TO OUR NOTICE ANY DISTINGUISHING FEATUR E IN THE FACTS OF THE CURRENT YEAR VIS--VIS THE REFERRED YEAR, RESPECTFULLY FOLLOWING THE PRECEDENT, WE UPHOLD THE IMPUGNED ORDER IN ALLOWING DEDUCTION FOR A SUM OF RS.37.03 LAC, WHICH HAS BEEN ADMITTEDLY CLAI MED ON THE SAME PERCENTAGE OF 25% AS FOR THE YEAR DEALT WITH BY THE TRIBUNAL. THIS GROUND FAILS. 13.1. THE LAST GROUND IS AGAINST THE DELETION OF ADDITION OF RS.2 LAC ON ACCOUNT OF DISALLOWANCE OF MISCELLANEOUS EXPENSES. THE ASSESSEE DEBITED A SUM OF RS.20.14 LAC UNDER THIS HEAD. FOR NON-AVAILABILITY OF CERTAIN DETAILS, THE AO MADE AN AD HOC DISALLOWANCE OF RS.2 LAC, WHICH WAS DELETED IN THE FIRST APPEAL. 13.2. HAVING HEARD THE RIVAL SUBMISSIONS AND PE RUSED THE RELEVANT MATERIAL ON RECORD, WE ARE SATISFIED WITH THE DECIS ION OF THE LD. CIT(A) IN DELETING THIS AD HOC ADDITION MADE BY THE AO. IF THE AO WAS NOT SATISFIED WITH THE JUSTIFICATION OF SOME EXPENSES, HE OUGHT TO HAVE ITA NO.1783/DEL/2011 CO NO.179/DEL/2011 26 SPECIFICALLY POINTED OUT SUCH EXPENSES RATHER THAN MAKING AN AD HOC DISALLOWANCE OF RS.2 LAC. WE, THEREFORE, APPROVE T HE VIEW TAKEN BY THE LD. CIT(A) ON THIS SCORE. THIS GROUND IS NOT ALLOWE D. 14. IN THE RESULT, THE APPEAL OF THE REVENUE IS PAR TLY ALLOWED FOR STATISTICAL PURPOSES AND THE CROSS OBJECTION OF TH E ASSESSEE IS DISMISSED. THE ORDER PRONOUNCED IN THE OPEN COURT ON 12.08.201 5. SD/- SD/- [A.T. VARKEY] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER DATED, 12 TH AUGUST, 2015. DK COPY FORWARDED TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT (A) 5. DR, ITAT AR, ITAT, NEW DELHI.