ADVANCE POWER DISPLAY SYSTEMS LTD, MUMBAI V. ASST CIT 8(1), MUMBAI

ITA 6490/MUM/2012

• Counselvise Citation: 649019914 RSA 2012
• Duration Of Justice: 1 year(s) 1 month(s) 4 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 29-11-2013
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: K
• Next Hearing Date: 19-11-2013
• Assessment Year: 2008-2009
• Appeal Filed On: 25-10-2012
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: AJEET KUMAR JAIN
• Assessee Lawyers: MILIN THAKARE
• Keywords: Depreciation; Transfer pricing; International transaction
• Section: 92; 14A; 10B

Judgement Text

, IN THE INCOME TAX APPELLATE TRIBUNAL K BENCH, MUMBAI . . , , , BEFORE SHRI P.M. JAGTAP , ACCOUNTANT MEMBER AND SHRI AMIT SHUKLA , JUDICIAL MEM BER . / ITA NO. 6490 / MUM./ 2012 ( / ASSESSMENT YEAR : 20 08 09 ) . / ITA NO. 7504 / MUM./ 2010 ( / ASSESSMENT YEAR : 20 06 07 ) ADVANCE POWER DISPLAY SYSTEMS LTD. UNIT NO.8, SDF 1, SEEPZ ANDHERI (E), MUMBAI 40 0 096 .. / APPELLANT V/S A SSTT . COMMISSIONER OF INCOME TAX RANGE 8 ( 1 ), AAYAKAR BHAVAN 101, M.K. ROAD, MUMBAI 400 020 .... / RESPONDENT . / PERMANENT ACCOUNT NUMBER AAA C A5970G / REVENUE BY : MR. AJ EE T KUMAR JAIN / ASSESSEE BY : MR. MILIN THAKARE / DATE OF HEARING 13 . 11 .2013 / DATE OF ORDER 29.11.2013 ADVANCE POWER DISPLAY SYSTEMS LTD. 2 / ORDER , / PER AMIT SHUKLA , J.M. THE PRESENT APPEALS HAVE BEEN PREFERRED BY THE ASSESSEE CHALLENGING THE IMPUGNED SEPARATE FINAL ASSESSMENT ORDER S PASSED FOR THE ASSESSMENT YEARS 2006 07 AND 2008 09, BY THE ASSESSING OFFICER IN PURSUANCE OF THE DIRECTIONS U NDER SECTION 144C(5) OF THE INCOME TAX ACT, 1961 (FOR SHORT 'THE ACT' ) GIVEN BY THE DISPUTE RESOLUTION PANEL (DRP), MUMBAI. SINCE THE FACTS AND CIRCUMSTANCES OF BOTH THE APPEALS ARE IDENTICAL AND THE ISSUES INVOLVED ARE COMMON, THEREFORE, AS A MATTER OF CO NVENIENCE, THESE WERE HEARD TOGETHER AND ARE BEING DISPOSED OFF BY WAY OF THIS CONSOLIDATED ORDER. 2 . WE FIRST TAKE UP APPEAL IN ITA NO. 7504 /MUM./2010, FOR THE ASSESSMENT YEAR 2006 07, VIDE WHICH , FOLLOWING ISSUES HAVE BEEN RAISED: I ) THE FIRST AND THE FOREM OST ISSUE RAISED BY THE ASSESSEE IS WITH REGARD TO THE TRANSFER PRICING ADJUSTMENT OF ` 5.34 CRORES MADE BY THE T RANSFER PRICING OFFICER (TPO) ; II ) THE SECOND ISSUE RELATES TO DISALLOWANCE UNDER SECTION 14A OF THE ACT; AND III ) THE THIRD ISSUE RELATES TO CHARGING OF INTEREST UNDER SECTION 234B. 3 . WITH REGARD TO THE TRANSFER PRICING ADJUSTMENT, THE ASSESSEE HAS RAISED AS MANY AS TWELVE SUB GROUNDS CHALLENGING THE VARIOUS ASPECTS REGARDING THE ADJUSTMENT MADE BY THE TPO AND CONFIRMED BY THE DRP. 4 . FACTS IN BRIEF : THE ASSESSEE IS AN EXPO RT ORIENTED UNIT WHICH IS ENGAGED IN THE BUSINESS OF MANUFACTURING ASSEMBLING AND TESTING OF SWITCH ADVANCE POWER DISPLAY SYSTEMS LTD. 3 MODE POWER SUPPLIES (FOR SHORT SMPS ) USED IN THE COMPUTER NETWORKING DEVICES. ALL ITS INTERNATIONAL TRANSACTIONS DURING THE YEAR RELAT ES TO IMPORT OF RAW MATERIALS, CONSUMABLES AND EXPORT OF SMPS AND IMPORT OF FIXED ASSETS WITH ITS A.ES . IN THE TRANSFER PRICING STUDY REPORT, FOLLOWING INTERNATIONAL TRANSACTIONS HAVE BEEN REPORTED. SR. NO. NAME OF THE A.E. NATURE OF INTERNATIONAL TRANSAC TION AMOUNT (IN CRORES) METHOD USED 1. QUALITY COMPONENTS & SYSTEMS PTE LTD., SINGAPORE IMPORT OF RAW MATERIAL, CONSUMABLES, ETC. 52.61 CPM 2. Q.C. SYSTEMS INC., USA IMPORT OF RAW MATERIAL, CONSUMABLES, ETC. 3.38 CPM 3. QUALITY COMPONENTS & SYSTEMS PT E LTD. SINGAPORE EXPORT OF POWER SUPPLIES 83.05 CPM 4. Q.C. SYSTEMS INC., USA EXPORT OF SUB ASSEMBLIES 0.007 CPM 5. QUALITY COMPONENTS & SYSTEMS PTE LTD., SINGAPORE IMPORT OF FIXED ASSETS 47.37 CPM 6. QC SYSTEM INC. USA IMPORT OF FIXED ASSETS 0.08 CP M FOR BENCH MARKING ITS TRANSACTIONS, THE ASSESSEE HAS ADOPTED COST PLUS METHOD ( CPM ) AS THE MOST APPROPRIATE METHOD. IT HAS COMPUTED ITS CPM @ 5.46% AND BENCH MARKED THE SAME AFTER CONSIDERING FIVE COMPARABLES HAVING AN AVERAGE PLI OF ( ) 2.35%. WHILE COMPUTI NG THE MARGIN , THE ASSESSEE HAD REDUCED THE FIXED EXPENDITURE OF ` 2.52 CRORES ON ACCOUNT OF LOWER CAPACITY UTILIZATION. THE TPO REJECTED THE ASSESSEES METHOD OF DETERMINING THE PLI AND COMPUTED THE ASSESSEES PLI MARGIN @ 2.33% AFTER TAKING SEVEN COMPARA BLES WHEREIN THE AVERAGE PLI WORKED OUT AT 8.90% AND ACCORDINGLY , MADE THE ADJUSTMENT OF ` 5.34 CRORES. WHILE DOING SO, IN PRINCIPLE, HE HAS GIVEN ADJUSTMENT OF LOW CAPACITY UTILIZATION BUT ONLY ADVANCE POWER DISPLAY SYSTEMS LTD. 4 INCLUDED EXPENDITURE FOR LEASE RENT, INSURANCE, RENT AS ITEMS OF FIXED COST AND EXCLUDED ALL OTHER EXPENDITURE WHICH WAS CONSIDERED BY THE ASSESSEE. FURTHER, THE ASSESSING OFFICER HAS ALSO MADE DISALLOWANCE OF ` 3,53,207 UNDER SECTION 14A. 5 . AGAINST THE DRAFT ASSESSMENT ORDER, THE ASSESSEE FILED DETAIL OBJECTIONS BEF ORE THE DRP CHALLENGING THE TRANSFER PRICING ADJUSTMENT MADE BY THE TPO ON VARIOUS COUNTS. HOWEVER, THE DRP, IN A VERY SUMMARILY MANNER, HAS REJECTED THE ASSESSEES OBJECTION. 6 . THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT BEFORE THE DRP , THE ASSESSE E HAS FILED NOT ONLY A VERY DETAIL OBJECTION BUT ALSO FILED VARIOUS DOCUMENTS TO JUSTIFY ITS MARGIN WITH THE A.E. THE ASSESSEE HAS POINTED OUT VARIOUS LACUNA AND ERRORS IN THE APPROACH OF THE TPO. IN SUPPORT OF THE SAME, H E DREW OUR ATTENTION TO VARIOUS OB JECTIONS AND THE EVIDENCES FILED BEFORE THE DRP. WITHOUT EXAMINING SUCH DETAILS AND OBJECTIONS, THE DRP HAS CONFIRMED THE ORDER PASSED BY THE ASSESSING OFFICER AS WELL AS THE TPO WITHOUT APPLICATION OF MIND, THEREFORE, SUCH AN ORDER PASSED IN PURSUANCE OF DRPS DIRECTION CANNOT BE LEGALLY SUSTAINABLE. 7 . ON THE OTHER HAND, THE LEARNED DEPARTMENTAL REPRESENTATIVE, MR. AJEET JAIN, ON BEHALF OF THE REVENUE, SUBMITTED THAT THE TPO HAS GIVEN ITS DETAIL REASONING FOR MAKING THE ADJUSTMENT WHICH HAS BEEN APPROVED BY THE DRP, THEREFORE, THERE IS NO INFIRMITY IN THE SAID ORDER. IN ANY CASE, HE SUBMITTED THAT IF REQUIRED THE MATTER CAN BE SET ASIDE TO THE FILE OF THE DRP FOR FRESH ADJUDICATION. 8 . WE HAVE HEARD THE RIVAL CONTENTIONS, PERUSED THE FINDINGS OF THE AUTHORITI ES BELOW AND THE MATERIAL PLACED ON RECORD. ON A PERUSAL OF THE DETAIL OBJECTIONS MADE BY THE ASSESSEE BEFORE THE DRP AND ALSO VARIOUS DOCUMENTS WHICH HAVE BEEN PLACE IN THE PAPER BOOK, IT IS SEEN THAT THE DRP HAS FAILED TO CONSIDER OR EXAMINE THE ASSESSEE S CONTENTION NOT ONLY ON THE ISSUE OF ADJUSTMENT OF LOW CAPACITY UTILIZATION BUT ALSO ON DETERMINATION OF ADVANCE POWER DISPLAY SYSTEMS LTD. 5 PLI BY THE TPO. THE ASSESSEE HAS ALSO RAISED OBJECTIONS WITH REGARD TO CERTAIN COMPARABLES. ALL THESE OBJECTIONS AND SUBMISSIONS HAVE BEEN BRUSHED AS IDE WITHOUT ANY PROPER ADJUDICATION ON THE OBJECTIONS AND ASSIGNING ANY REASONS. THE RELEVANT POINTS RAISED ON BEHALF OF THE ASSESSEE DO NOT FIND ANY MENTION OR PROPER DISCUSSION IN DRPS DIRECTION WHICH IT IS OBLIGED TO DO SO. THE DRP IS A QUASI JUDICIAL AUTHORITY AND WHEN DEALING WITH A LIS PENDING BEFORE IT, IT IS OBLIGATORY ON ITS PART TO ASCRIBE COGENT REASONS AS TO WHY THE ASSESSEES CONTENTIONS ARE NOT ACCEPT ABLE . IN THE PRESENT CASE, NO SUCH FINDING OR REASONS HAVE BEEN GIVEN IN ITS ORDER. THEREFORE , IN THE INTEREST OF SUBSTANTIAL JUSTICE, WE ARE OF THE CONSIDERED OPINION THAT THE ENTIRE MATTER NEEDS TO BE RESTORED BACK TO THE FILE OF THE DRP . CONSEQUENTLY, WE SET ASIDE THE IMPUGNED FINAL ASSESSMENT ORDER AND RESTORE THE ENTIRE ISSUE BACK TO THE FILE OF THE DRP WITH DIRECTION TO CONSIDER THE OBJECTIONS OF THE ASSESSEE AND PASS A PROPER AND SPEAKING ORDER WHILE DEALING WITH THE ISSUE S ON MERIT. EVEN THE ISSUE OF DISALLOWANCE UNDER SECTION 14A DESERVES TO BE ADJUDICATED AFRESH. THEREFORE, THE ISSUE RELA TING TO DISALLOWANCE UNDER SECTION 14A IS ALSO RESTORED TO THE FILE OF THE DRP FOR DENOVO ADJUDICATION. THUS, THE GROUNDS RAISED ARE TREATED AS ALLOWED FOR STATISTICAL PURPOSES. 9 . 2006 07 9. IN THE RESULT, ASSESSEES APPEAL FOR ASSESSMENT YEAR 2006 07 IS ALLOWED FOR STATISTICAL PURPOSES. WE NOW TAKE UP ASSESSEES APPEAL IN ITA NO.6490/MUM./2012, FOR THE ASSESSMENT YEAR 2008 09 , VIDE WHICH, THE MAIN ISSUE RELATES T O TRANSFER PRICING ADJUSTMENT OF ` 11,66,78,804. 10 . IN THIS YEAR, THE ASSESSEE AS WELL AS THE TPO HAS ACCEPTED THE CP M AS THE MOST APPROPRIATE METHOD OF BENCH MARKING THE TRANSACTIONS . THE ASSESSEE HAS COMPUTED ITS COST PLUS MARGIN AT 7.14% AND BENCH MARKED THE SAME WITH 10 COMPARABLE COMPANIES HAVING AN AVERAGE PLI OF 5.37%. IN THIS ADVANCE POWER DISPLAY SYSTEMS LTD. 6 YEAR ALSO, THE ASSESSEE, WHILE COMPUTING THE MARGIN HAD REDUCED THE FIXED EXPENDITURE OF ` 3,39,42,746 ON ACCOUNT OF LOWER CAPACITY UTILIZATION AND HAS FURTHER MADE AN ADJUSTMENT ON ACCOUNT OF INCREASE IN ELECTRICITY TARIFF RATE OF ` 1,89,86,454. THE TPO, HOWEVER, REJECTED THE ASSESSEES DETERMINATION OF PLI AND HIMSELF COMPUTED THE ASSESSEES PLI AT 3.23% AND AFTER TAKING THE AVERAGE PLI OF EIGHT COMPARABLES, WHICH WAS @ 11.27%, H AS MADE AN UPWARD ADJUSTMENT. WHILE DOING SO, HE DID NOT ALLOW ANY ADJUSTMENT ON ACCOUNT OF LOW CAPACITY UTILIZATION. FROM THE ANNUAL ACCOUNTS OF THE ASSESSEE, THE TPO OBSERVED THAT THE ASSESSEES EXPLANATION REGARDING LOW CAPACITY UTILIZATION IS NOT CORRE CT AS THE CAPACITY UTILIZATION AS PER ASSESSEES OWN ANNUAL REPORT IS 85.95% AND NOT 20.22% AS CLAIMED BY THE ASSESSEE. THUS, THE VERY BASIS OF ASSESSEES CLAIM WAS NEGATED BY THE TPO. FURTHER, HE REJECTED THE TWO COMPARABLES OF THE ASSESSEE AND DETERMINED THE AVERAGE PLI OF THE COMPARABLES AT 11.27%. IN RESPECT OF PURCHASE OF FIXED ASSET FROM THE A.E., THE TPO HAS APPLIED CUP METHOD AS AGAINST CPM APPLIED BY THE ASSESSEE AND MADE AN ADJUSTMENT OF ` 3,99,075. 11 . BEFORE THE DRP, THE ASSESSEE MADE SPECIFIC OBJE CTIONS AND ALSO MADE A DETAIL REBUTTAL OF THE OBSERVATIONS MADE BY THE TPO ON CAPACITY UTILIZATION. HOWEVER, THE DRP CONFIRMED THE TPOS OBSERVATION AND REJECTED THE ASSESSEES ENTIRE OBJECTION. 12 . BEFORE US, THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED TH AT THE ANNUAL LICENSE CAPACITY AND ANNUAL INSTALLED CAPACITY OF ASSESSEES PRODUCTION WAS 17.00 LAKHS IN THE ASSESSMENT YEAR S 200 5 06 AND 2006 07 . THE SAME ANNUAL CAPACITY CONTINUES IN THIS YEAR ALSO. HOWEVER, BY MISTAKE, IN THE ANNUAL ACCOUNTS, THE ASSESS EES ANNUAL LICENSE CAPACITY AND ANNUAL INSTALLED CAPACITY HAVE BEEN MENTIONED AT ` 4 LAKHS WHICH IN FACT SHOULD HAVE BEEN ` 17 LAKHS AS WAS THERE IN THE EARLIER YEARS. AS AGAINST THE ANNUAL CAPACITY, THE ASSESSEE HAS UTILIZED ONLY 20.22%. THEREFORE, WHILE MAKING A COMPARISON WITH THE COMPARABLE COMPANIES, ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION HAS TO BE MADE. IN SUPPORT OF HIS CONTENTION ABOUT THE INSTALLED CAPACITY, THE ADVANCE POWER DISPLAY SYSTEMS LTD. 7 LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT FRESH EVIDENCES WERE FILED BEFO RE THE DRP WHICH HAS NOT BEEN CONSIDERED AT ALL. REGARDING THE ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION, THE LEARNED COUNSEL STRONGLY RELIED UPON THE DECISION OF THE CO ORDINATE BENCH IN CIT V/S PETRO ARALDITE PVT. LTD., ITA NO.3782/MUM./2011, ORDER D ATED 24 TH JULY 2013, WHEREIN THE TRIBUNAL HAS GIVEN A DETAIL GUIDELINES FOR ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION. HE FURTHER MADE DETAIL SUBMISSIONS ON OTHER ISSUES ALSO. 13 . THE LEARNED DEPARTMENTAL REPRESENTATIVE, ON THE OTHER HAND, SUBMITTED THAT NOT ONLY THE TPO HAS EXAMINED THE ASSESSEES CLAIM FOR CAPACITY UTILIZATION BUT ALSO FOUND THAT THE ASSESSEES CONTENTION IS INCORRECT IN VIEW OF THE STATEMENT GIVEN IN THE AUDITED FINANCIAL STATEMENT. REGARDING THE EVIDENCE FILED BEFORE THE DRP, HE SUBMIT TED THAT THEY ARE THE CERTIFICATE FROM THE AUDITORS AND LETTER FROM THE DIRECTOR WHICH CANNOT BE SAID TO BE INDEPENDENT EVIDENCE IN SUPPORT OF THE ASSESSEES CLAIM ABOUT THE CAPACITY UTILIZATION. ON MERITS, HE SUBMITTED THAT HE IS READY TO ARGUE ON THE ISS UE OF CAPACITY UTILIZATION ALSO. HOWEVER, HE SUBMITTED THAT IT WOULD BE PROPER TO FIRST DETERMINE WHAT IS THE ANNUAL CAPACITY UTILIZATION OF THE ASSESSEE AND THE ACTUAL UTILIZATION WHICH CAN ONLY BE DONE IF THE MATTER CAN BE SENT BACK TO THE FILE OF THE AS SESSING OFFICER. 14 . WE HAVE HEARD THE RIVAL CONTENTIONS, PERUSED THE RELEVANT FINDINGS OF THE AUTHORITIES BELOW AND THE MATERIAL PLACED ON RECORD. ONE OF THE MAJOR OBJECTIONS OF THE ASSESSEE IS THAT THE ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION HAS NOT B EEN GIVEN BY THE TPO ON THE GROUND THAT THE VERY BASIS OF THE ASSESSEES CLAIM HAS BEEN REFUTED BY HIM. THIS HAS BEEN AFFIRMED BY THE DRP ALSO. FROM THE RECORDS, IT IS SEEN THAT IN THE ASSESSMENT YEARS 2005 06 AND 2006 07, THE ANNUAL LICENSED CAPACITY AND ANNUAL INSTALLED CAPACITY IS 17 LAKHS WHICH HAS BEEN MENTIONED AS 4 LAKHS IN THE ASSESSMENT YEAR 2008 09. PRIMA FACIE, THERE APPEARS TO BE INHERENT CONTRADICTION IN THIS FIGURES. THE ASSESSEE HAS FILE D CERTIFICATE FROM THE AUDITOR AND ALSO LETTERS FROM TH E DIRECTOR. HOWEVER, THESE DOCUMENTS HAVE NOT BEEN CONSIDERED BY THE DRP. IN ADVANCE POWER DISPLAY SYSTEMS LTD. 8 ORDER TO EXAMINE THE VERACITY OF ASSESSEES CONTENTION ABOUT THE ANNUAL CAPACITY AND THE ACTUAL UTILIZATION, THE MATTER NEEDS TO BE RESTORED BACK TO THE FILE OF THE TPO. ACCORDIN GLY, WE SET ASIDE THE IMPUGNED FINAL ASSESSMENT ORDER TO THE FILE OF THE TPO, WHEREIN THE ASSESSEE WILL PRODUCE ALL THE NECESSARY EVIDENCES TO SHOW WHAT IS ITS CORRECT ANNUAL CAPACITY AND ACTUAL CAPACITY UTILIZATION. THE ASSESSING OFFICER, AFTER VERIFYING THE SAME, WILL ACCORDINGLY DEAL WITH THE ISSUE OF ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION AND OTHER CONTENTIONS RAISED BY THE ASSESSEE. WHILE DOING SO, THE ASSESSING OFFICER MAY ALSO CONSIDER THE RATIO AND PRINCIPLE LAID DOWN BY THE TRIBUNAL I N M/S. PETRO ARALDITE PVT. LTD. (SUPRA) , WHEREIN IT HAS BEEN OBSERVED AND HELD AS UNDER: ADJUSTMENT FOR THE CAPACITY UTILIZATION . 19. THERE BEING DIFFERENCE IN THE CAPACITY UTILIZATION OF THE ASSESSEE VIS - - VIS THE COMPARABLES, ADJUSTMENT ON ACCOUNT OF CAPA CITY UTILIZATION WAS CLAIMED BY THE ASSESSEE. ACCORDING TO THE ASSESSEE, IF THE PROFIT MARGIN IS TAKEN BEFORE DEPRECIATION BY ADOPTING EARNING BEFORE DEPRECIATION, INTEREST AND TAX (EBDIT) AS PLI, THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFIT MARGIN CAN BE NULLIFIED. THE TPO DID NOT APPROVE THIS METHOD ADOPTED BY THE ASSESSEE FOR MAKING ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION WHEREAS THE LD. CIT(A) FOUND THE SAME TO BE ACCEPTABLE HOLDING THAT THE UNDER UTILIZATION OF CAPACITY RESULTS IN U NDER RECOVERY OF FIXED EXPENSES LIKE DEPRECIATION AND IF THE DEPRECIATION IS EXCLUDED, THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFIT MARGIN CAN BE NULLIFIED. BEFORE WE PROCEED TO DEAL WITH THE ISSUE OF ADJUSTMENT FOR DIFFERENCE IN CAPACITY UTI LIZATION, IT IS NECESSARY FIRST TO SEE THE PROCEDURE LAID DOWN FOR CARRYING OUT THE EXERCISE OF COMPARABILITY ANALYSIS AND MAKING SUITABLE ADJUSTMENTS. THIS PROCEDURE AS LAID DOWN IN SECTION 92 - C OF THE ACT PROVIDES THAT THE ALP IN RELATION TO AN INTERNATI ONAL TRANSACTION SHALL BE DETERMINED BY ANY OF THE METHODS SPECIFIED THEREIN, BEING THE MOST APPROPRIATE METHOD AND THE MANNER IN WHICH THE SAID ALP HAS TO BE DETERMINED IS GIVEN IN SECTION 92 - C(2) OF THE ACT READ WITH RULE 10B OF THE INCOME TAX RULES, 196 2 IN RESPECT OF EACH METHOD SEPARATELY. CLAUSE (E) OF RULE 10 - B STIPULATES THE MANNER IN WHICH THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION IS TO BE DETERMINED BY FOLLOWING THE TRANSACTIONAL NET MARGIN METHOD AS UNDER: - (E) TRANSACTIONAL NET MARGIN METHOD, BY WHICH, - (I) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE FROM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSOCIATED ENTERPRISE IS COMPUTED IN RELATION TO COSTS INCURRED OR SALES EFFECTED OR ASSETS ADVANCE POWER DISPLAY SYSTEMS LTD. 9 EMPLOYED OR TO BE EMPLOYED B Y THE ENTERPRISE OR HAVING REGARD TO ANY OTHER RELEVANT BASE; (II) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE OR BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED TRANSACTION OR A NUMBER OF SUCH TRANSACTIONS IS COMPUTED HAVING REGARD TO THE SAME BASE; (III) THE NET PROFIT MARGIN REFERRED TO IN SUB - CLAUSE (II) ARISING IN COMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES, IF ANY, BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSA CTIONS, OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS, WHICH COULD MATERIALLY AFFECT THE AMOUNT OF NET PROFIT MARGIN IN THE OPEN MARKET; (IV) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE 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; 20. KEEPING IN VIEW THE AF ORESAID PROVISIONS OF THE RELEVANT RULE, WE CAN NOW ENDEAVOR TO CONSIDER HOW AND TO WHAT EXTENT THE DIFFERENCE IN CAPACITY UTILIZATION AFFECTS THE PROFIT MARGIN AND HOW THE ADJUSTMENT ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION CAN APPROPRIATELY BE MA DE WITHIN THE FRAME WORK OF RULE 10B. THE ISSUE OF DIFFERENCE IN CAPACITY UTILISATION GENERALLY COMES IN THE CASE OF MANUFACTURING CONCERN AND LIKE ANY OTHER BUSINESS UNDERTAKING, THE MANUFACTURING CONCERN HAS MAINLY TWO TYPES OF OVERHEADS I.E. FIXED OVERH EADS AND VARIABLE OVERHEADS. THE VARIABLE OVERHEADS VARY IN PROPORTION TO THE SALES AND THEY THEREFORE DO NOT HAVE ANY EFFECT ON THE PROFIT MARGIN AS A RESULT OF DIFFERENCE IN CAPACITY UTILIZATION. THE FIXED OVERHEADS, ON THE OTHER HAND, DO NOT VARY WITH T HE VOLUME OF SALES AND SINCE THEY REMAIN BY AND LARGE STATIC IRRESPECTIVE OF LEVEL OF CAPACITY UTILIZATION, THE PROFIT MARGIN GETS AFFECTED AS A RESULT OF DIFFERENCE IN CAPACITY UTILIZATION ON THIS COUNT. THE UNDER UTILIZATION OF CAPACITY RESULTS IN OVER A LLOCATION OR OVER ABSORPTION OF FIXED OVERHEADS RESULTING INTO UNDER - RECOVERY OF FIXED OVERHEADS WHICH ADVERSELY AFFECTS THE PROFIT MARGIN. AS THE LEVEL OF CAPACITY UTILIZATION GOES UP, THE RATE OF ALLOCATION OR ABSORPTION OF FIXED OVERHEADS TO SALES COMES DOWN RESULTING INTO HIGHER PROFIT MARGIN. THE FOLLOWING SIMPLE EXAMPLE WOULD FURTHER EXPLAIN THIS POSITION: INSTALLED CAPACITY IN MONITORY TERMS RS.10 CRORES RS. 10 CRORES RS. 10 CRORES CAPACITY UTILISATION 50% 60% 80% SALES RS. 5 CRORES RS. 6 CR ORES RS.8 CRORES ADVANCE POWER DISPLAY SYSTEMS LTD. 10 VARIABLE OVERHEADS AT 50% RS.2.5 CRORES RS.3 CRORES RS. 4 CRORES FIXED OVERHEADS RS.2 CRORES RS. 2 CRORES RS. 2 CRORES NET PROFIT RS.0.5 CRORES RS. 1 CRORE RS. 2 CRORES PROFIT MARGIN (OP/SALES) 10% 16.67% 25% 21. THE ABOVE EXAM PLE SHOWS THAT THE PROFITABILITY CHANGES WITH THE CHANGE IN THE LEVEL OF CAPACITY UTILIZATION WITH HIGHER PROFITABILITY AT HIGHER UTILIZATION AND LOWER PROFITABILITY AT LOWER REALIZATION. THIS HAPPENS MAINLY BECAUSE OF HIGHER ALLOCATION OR ABSORPTION OF FI XED OVERHEADS AT LOWER CAPACITY UTILIZATION WHICH COMES DOWN AS THE LEVEL OF CAPACITY UTILIZATION GOES UP. FOR INSTANCE, AS GIVEN IN THE ABOVE EXAMPLE, THE RATE OF ALLOCATION OR ABSORPTION OF FIXED OVERHEADS TO SALES IS 40% AT 50% CAPACITY UTILIZATION WHIL E IT BECOMES 33.33% AT 60% CAPACITY UTILIZATION AND 25% AT 80% CAPACITY UTILIZATION GIVING MORE PROFIT MARGIN OF 16.67% AT 60% CAPACITY UTILIZATION AND 25% AT 80% CAPACITY UTILIZATION AS AGAINST PROFIT MARGIN OF 10% AT 50% CAPACITY UTILIZATION. THE DIFFERE NCE IN CAPACITY UTILIZATION THUS MATERIALLY AFFECTS THE PROFIT MARGIN AND IF THERE IS A DIFFERENCE IN THE LEVEL OF CAPACITY UTILIZATION OF THE ASSESSEE AND THE LEVEL OF CAPACITY UTILIZATION OF THE COMPARABLE COMPANIES, ADJUSTMENT IS REQUIRED TO BE MADE TO THE PROFIT MARGIN OF THE COMPARABLES ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION AS PER CLAUSE (E)(III) OF SUB - RULE (1) OF RULE 10 - B OF THE INCOME TAX RULES, 1962. 22. HAVING HELD THAT THE ADJUSTMENT IS REQUIRED TO BE MADE TO THE NET MARGIN OF THE COMPARABLES ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILISATION, THE NEXT ISSUE THAT ARISES IS REGARDING THE ADOPTION OF PROPER METHOD BY WHICH THE SAME CAN APPROPRIATELY BE MADE. IN THE PRESENT CASE, THE ASSESSEE MADE THIS ADJUSTMENT BY NOT CONSIDERING DEPRE CIATION FOR COMPUTING ITS OWN OPERATING PROFIT AS WELL AS THE OPERATING PROFIT OF COMPARABLE. IT WAS DONE BY TAKING EBDIT AS PLI INSTEAD OF EBIT. ALTHOUGH THIS METHOD ADOPTED BY THE ASSESSEE WAS NOT APPROVED BY THE TPO, IT WAS ACCEPTED BY THE LD. CIT(A) ON THE GROUND THAT THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFITABILITY COULD BE NULLIFIED BY TAKING EBDIT AS PLI INSTEAD OF EBIT. WE ARE UNABLE TO CONCUR WITH THIS VIEW OF THE LD. CIT(A). IN OUR OPINION, WHEN THE PLI IS TAKEN AS OP TO SALES OR OP TO COST, OPERATING PROFIT OF THE ASSESSEE AS WELL AS COMPARABLE CASES BECOMES RELEVANT AND THE DEPRECIATION BEING VERY MUCH INTEGRAL PART OF THE OPERATING EXPENSES OF THE MANUFACTURING CONCERN, THE SAME CANNOT BE EXCLUDED FOR THE PURPOSE OF COMPUTING OP ERATING PROFIT . MOREOVER, CLAUSE (E)(I) OF SUB RULE (1) OF RULE 10 - B REQUIRES THAT THE NET PROFIT MARGIN OF THE ASSESSEE IS TO BE WORKED OUT WHILE CLAUSE (E)(II) OF THE SAID SUB RULE REQUIRES THAT NET PROFIT MARGIN OF THE COMPARABLES IS WORKED OUT. CLAUS E (E)(III), WHICH PERMITS THE ADJUSTMENTS, CLEARLY STIPULATES THAT ANY ADJUSTMENT ON ACCOUNT OF ADVANCE POWER DISPLAY SYSTEMS LTD. 11 DIFFERENCES AFFECTING MATERIALLY THE PROFITABILITY IS TO BE MADE TO THE NET PROFIT MARGIN OF THE COMPARABLES AS REFERRED TO IN CLAUSE (E)(II). BY TAKING THE NE T PROFIT MARGIN OF THE ASSESSEE WITHOUT CONSIDERING THE DEPRECIATION IN ORDER TO MAKE ADJUSTMENT ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION, WHAT THE ASSESSEE HAS SOUGHT TO DO IS TO MAKE ADJUSTMENT TO THE NET PROFIT MARGIN OF THE ASSESSEE AS REFERRED TO IN CLAUSE (E)(I) OF SUB RULE (1) OF RULE 10B, WHICH IN OUR OPINION, IS NOT PERMISSIBLE IN ACCORDANCE WITH CLAUSE (E)(III) OF SUB RULE (1) OF RULE 10B. 23. THE QUESTION THAT NOW ARISES IS WHAT IS THE PROPER METHOD OF MAKING ADJUSTMENT FOR DIFFERENCE IN CAPACITY UTILIZATION WITHIN THE FRAME WORK GIVEN IN RULE 10B. AS ALREADY DISCUSSED BY US, THE DIFFERENCE IN CAPACITY UTILIZATION AFFECTS THE PROFITABILITY MAINLY BECAUSE OF THE DIFFERENCE IN RATES AT WHICH THE FIXED OVERHEADS ARE ABSORBED OR ALLOCATED D EPENDING ON THE LEVEL OF CAPACITY UTILIZATION. THE EXAMPLE GIVEN BY US CLEARLY DEPICTS THIS POSITION. THE SAID EXAMPLE SHOWS THAT THE ALLOCATION OF FIXED OVERHEADS AT THE CAPACITY UTILIZATION OF 50%, 60% & 80% IS 40%, 33.33% & 25% RESPECTIVELY RESULTING IN THE PROFIT MARGIN OF 10%, 16.67% AND 25%. IN OUR OPINION, IF THE FIXED OVERHEADS ALLOCATION OR ABSORPTION OF COMPARABLE IS BROUGHT AT THE LEVEL OF THE ASSESSEE, IT WOULD NULLIFY THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON THE PROFIT MARGIN. FOR EX AMPLE, IF WE TAKE THE PROFITABILITY WORKING AT 50% CAPACITY UTILIZATION AS THAT OF THE TESTED PARTY AND AT CAPACITY UTILIZATION OF 60% AND 80% AS THAT OF THE COMPARABLES AND ADJUST THE RATE OF ALLOCATION OF FIXED OVERHEADS OF THE COMPARABLES IN ORDER TO BR ING THE SAME AT PAR (I.E. 40% OF SALES) WITH THE TESTED PARTY, THE RESULTANT POSITION WILL BE AS UNDER: - NET PROFIT RS.1 CRORE RS. 2.00 CRORES LESS ADDITIONAL ALLOCATION OF DEPRECIATION BY TAKING THE RATE OF FIXED OVERHEADS AT 40% OF SALES: RS. 0.40 C RORES RS.1.20 CRORES NET PROFIT AFTER ADJUSTMENT RS. 0.60 CRORES RS. 0.80 CRORES PROFIT MARGIN AFTER ADJUSTMENT 10% 10% 24. THE ADJUSTMENT THUS CAN BE MADE TO THE PROFIT MARGIN OF THE COMPARABLES BY ALLOCATING FIXED OVERHEADS AT THE SAME RATE AT WHIC H FIXED OVERHEADS ARE ALLOCATED IN THE CASE OF THE TESTED PARTY. FOR EXAMPLE, IN THE CASE OF A COMPARABLE HAVING 80% CAPACITY UTILIZATION, THE RATE OF ALLOCATION OF DEPRECIATION IS 25% OF THE SALES AS AGAINST THE RATE OF ALLOCATION OF FIXED OVERHEADS OF 40 % IN THE CASE OF THE TESTED PARTY. IF THE ADJUSTMENT IS MADE IN THE PROFIT MARGIN OF THE SAID COMPARABLES BY ALLOCATING MORE FIXED OVERHEADS AT 15% OF SALES TO BRING THE RATE OF ALLOCATION OF FIXED OVERHEADS AT PAR WITH THAT OF THE TESTED PARTY, THE PROFIT OF THE COMPARABLE WOULD BE REDUCED BY RS. 1.20 CRORES THEREBY GIVING A NET PROFIT OF RS. 0.80 CRORES WHICH WOULD BRING THE PROFITABILITY TO 10%, I.E. AT PAR WITH THE TESTED PARTY. ADVANCE POWER DISPLAY SYSTEMS LTD. 12 SIMILARLY, IF THE ADJUSTMENT IS MADE IN THE PROFIT MARGIN OF A COMPARABLE H AVING 60% CAPACITY UTILIZATION BY ALLOCATING MORE FIXED OVERHEADS AT 6.67% OF SALES TO BRING THE RATE OF ALLOCATION OF FIXED OVERHEADS AT PAR WITH THAT OF THE TESTED PARTY, THE PROFIT OF THE SAID COMPARABLE WOULD BE REDUCED BY RS. 0.40 CRORES THEREBY GIVIN G A NET PROFIT OF RS. 0.60 CRORES WHICH WOULD BRING THE PROFITABILITY TO 10% I.E. AT PART WITH THE TESTED PARTY. 25. HAVING HELD THAT THE ADJUSTMENT ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION IS REQUIRED TO BE MADE AND HAVING EXPLAINED WITH ILLUST RATION THAT THE SAME CAN APPROPRIATELY BE MADE BY ABSORBING OR ALLOCATING FIXED OVERHEADS SUCH AS DEPRECIATION ON SALES OF THE COMPARABLE AT THE SAME RATE AS THAT OF THE TESTED PARTY, WE ARE OF THE VIEW THAT SUCH ABSORPTION OR ALLOCATIONS OF FIXED OVERHEAD S ON OPERATING COST INSTEAD OF SALES WOULD BE MORE APPROPRIATE AS THE SAME WILL ELIMINATE THE EFFECT OF DIFFERENCE IN PROFIT MARGIN OR DIFFERENCE IN LEVEL OF STOCK OF FINISHED GOODS, IF ANY, OF THE TESTED PARTY AND COMPARABLES. 26. IN SO FAR THE PRESENT CASE IS CONCERNED, IT IS OBSERVED THAT DEPRECIATION CLAIMED BY THE ASSESSEE IS RS. 6.15 CRORES WHICH IS 4.26% OF ITS OPERATING COST OF RS. 144.13 CRORES. IF THE DEPRECIATION IN CASE OF A COMPARABLE IS ALLOWED AT THE SAME RATE I.E. 4.26% OF ITS OPERATING C OST INSTEAD OF THE ACTUAL DEPRECIATION CLAIMED, IF IT IS LOWER, THIS ADJUSTMENT, IN OUR OPINION, WILL TAKE CARE OF DIFFERENCE IN CAPACITY UTILIZATION. WE ACCORDINGLY SET ASIDE THE IMPUGNED ORDER OF THE LD. CIT(A) EXCLUDING THE DEPRECIATION ENTIRELY FOR THE PURPOSE OF COMPUTING OPERATING PROFIT AND DIRECT THE A.O. TO MAKE THE ADJUSTMENT AS GIVEN ABOVE FOR DIFFERENCE IN CAPACITY UTILIZATION AFTER VERIFYING THE STAND OF THE ASSESSEE THAT THE CAPACITY UTILIZATION OF COMPARABLE COMPANY FINALLY SELECTED VIZ. RASI N PLASTIC LTD. WAS MORE BY 10 - 15% THAN THAT OF THE ASSESSEE DURING THE YEAR UNDER CONSIDERATION. GROUND NO. 1 OF THE REVENUES APPEAL IS THUS PARTLY ALLOWED WHEREAS GROUND NO. 2 & 3 ARE DISMISSED. IN VIEW OF THE ABOVE, THE ENTIRE MATTER OF TRANSFER PRICI NG ADJUSTMENT IS RESTORED TO THE FILE OF THE ASSESSING OFFICER TO DEAL AND DECIDE THIS ISSUE AFRESH AND IN ACCORDANCE WITH THE PROVISIONS OF LAW AND ALSO AFTER CONSIDERING THE RATIO OF THE AFORESAID DECISION OF THE TRIBUNAL. 15 . 20 0 8 09 15. IN THE RESULT, ASSESSEES APPEAL FOR THE ASSESSMENT YEAR 2008 09 IS ALLOWED FOR STATISTICAL PURPOSES. ADVANCE POWER DISPLAY SYSTEMS LTD. 13 16 . , 2006 07 200 8 09 16 . TO SUM UP, ASSESSEES APPEALS FOR THE ASSESSMENT YEAR 2006 07 AND 200 8 09 ARE ALLOWED FOR STATISTICAL PURPOSES. 29 TH NOVEMBER 2013 ORDER PRONOUNCED IN THE OPE N COURT ON 29 TH NOVEMBER 2013 SD / - . . P.M. JAGTAP ACCOUNTANT MEMBER SD / - AMIT SHUKLA JUDICIAL MEMBER MUMBAI, DATED : 29 TH NOVEMBER 2013 / COPY OF THE ORDER FORWARDED TO : ( 1 ) / THE ASSESSEE ; ( 2 ) / THE REVENUE; ( 3 ) ( ) / THE CIT(A ) ; ( 4 ) / THE CIT, MUMBAI CITY CONCERNED ; ( 5 ) , , / THE DR, ITAT, MUMBAI ; ( 6 ) / GUARD FILE . / TRUE COPY / BY ORDER . / PRADEEP J. CHOWDHURY / SR. PRIVATE SECRETARY / / (DY./ASSTT. REGISTRAR) , / ITAT, MUMBAI