DCIT RG 8(1) OSD, MUMBAI V. KIARA JEWELLERY P.LTD, MUMBAI

ITA 8109/MUM/2011

• Counselvise Citation: [2014] 120 COUNSELVISE.COM (IT) 6596 (ITAT-MUMBAI)
• Duration Of Justice: 2 year(s) 5 month(s) 5 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 07-05-2014
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: K
• Next Hearing Date: 03-04-2014
• Assessment Year: 2007-2008
• Appeal Filed On: 02-12-2011
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: VIVEK BATRA
• Assessee Lawyers: I M CONTRACTOR
• Keywords: Depreciation; Transfer pricing; International transaction
• Section: 92C; 143(3); 10B

Judgement Text

, IN THE INCOME TAX APPELLATE TRIBUNAL K BENCH, MUMBAI BEFORE S/SHRI P.M.JAGTAP (AM) AND VIVEK VARMA, (JM) . . , , ./I.T.A.NO.8109/MUM/2011 ( / ASSESSMENT YEAR: 2007-08) JOINT COMMISSIONER OF INCOME TAX CIRCLE 8(2),OSD ROOM NO.216-A, AAYAKAR BHAVAN, M.K.ROAD, MUMBAI-400020 / VS. M/S KIARA JEWELLERY P.LTD., UNIT NO.180 SDF-VI, SEEPZ SEZ, ANDHERI (E), MUMBAI-400096 ./ ./PAN/GIR NO. : AAACK4789M ( ' / APPELLANT) .. ( #$' / RESPONDENT) CROSS-OBJECTION NO.228/MUM/2012 IN ./I.T.A.NO.8109/MUM/2011 ( / ASSESSMENT YEAR:2007-08) M/S KIARA JEWELLERY P.LTD., UNIT NO.180 SDF-VI, SEEPZ SEZ, ANDHERI (E), MUMBAI-400096 / VS. DY. COMMISSIONER OF INCOME TAX CIRCLE 8(2), OSD, ROOM NO.216-A, AAYAKAR BHAVAN, M.K.ROAD, MUMBAI-400020 ' / APPELLANT) ( #$' / RESPONDENT) ' / REVENUE BY : SHRI VIVEK BATRA #$' & /ASSESSEE BY SHRI I M CONTRACTOR & ) / DATE OF HEARING : 3.4.2014 & ) /DATE OF PRONOUNCEMENT : 7. 5.2014 / O R D E R PER P.M.JAGTAP,AM: THIS APPEAL FILED BY THE REVENUE IS DIRECTED AGAIN ST THE ORDER OF LD. CIT(A)-15, MUMBAI DATED 19.9.2011 AND THE SAME IS BEING DISPO SED OFF ALONG WITH THE CROSS- OBJECTION FILED BY ASSESSEE BEING CO NO. 228/MUM/2 012. I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 2 2. THE SOLITARY COMMON ISSUE ARISING OUT OF THIS APPEAL OF THE REVENUE AND THE CROSS-OBJECTION OF THE ASSESSEE RELATES TO THE TRA NSFER PRICING ADJUSTMENT OF RS.1,01,06,805/- MADE BY THE ASSESSING OFFICER/ TR ANSFER PRICING OFFICER (TPO) WHICH HAS BEEN PARTLY SUSTAINED BY THE LD. CIT(A). 3. THE ASSESSEE IN THE PRESENT CASE IS JOINT VENTUR E COMPANY OF SAPHIRE PRODUCTS SA, SWITZERLAND AND SHRERUJ AND COMPANY LIMITED I NDIA. IT IS ENGAGED IN THE BUSINESS OF MANUFACTURING OF DIAMONDS AND PRECIOUS STONES S TUDDED JEWELLERY. THE RETURN OF INCOME FOR THE YEAR UNDER CONSIDERATION WAS FILED BY IT ON 22.10.2007 DECLARING LOSS OF RS.88,24,570/-. DURING THE COURSE OF ASSESSMENT PROCEEDINGS, IT WAS NOTICED BY AO FROM THE TRANSFER PRICING STUDY REPORT SUBMITTED B Y THE ASSESSEE THAT THE ASSESSEE HAS ENTERED INTO VARIOUS INTERNATIONAL TRANSACTIONS WI TH ITS ASSOCIATED ENTERPRISES (AE) INCLUDING TRANSACTIONS INVOLVING EXPORT OF STUDDED JEWELLERY TO ITS AE WORTH RS.12,77,59,946/-. HE, THEREFORE, MADE A REFERE NCE U/S 92CA(1) OF THE INCOME TAX ACT, 1961 (THE ACT) TO THE TPO FOR DETERMINING THE ARMS LENGTH PRICE OF THE SAID INTERNATIONAL TRANSACTIONS. DURING THE COURSE OF PROCEEDINGS BEFORE HIM, THE TPO FOUND THAT THE AVERAGE PROFIT MARGINS (OP/OC) OF THE COMPARABLE SELECTED WAS 5.31% AS AGAINST THE OP/OC OF THE ASSESSEE SHOWN AT (-2 .48%). IN THIS REGARD, THE EXPLANATION OFFERED BY THE ASSESSEE BEFORE THE TPO WAS THAT IT WAS OPERATING AT 50% OF ITS ACTUAL CAPACITY DURING THE YEAR UNDER CONSID ERATION AND THEREFORE ITS OPERATING PROFIT MARGIN WAS LOWER AS COMPARED TO ALL THE C OMPARABLES SELECTED. IT WAS POINTED OUT THAT THE CAPACITY UTILIZATION OF THE COMPARABLE S COMPANIES FOR THE YEAR CONSIDERATION WAS NOT AVAILABLE IN THE PUBLIC DOMAIN AND IF THE S AME WOULD BE TAKEN AT 75% AND SUITABLE ADJUSTMENT IS MADE TO THE PROFIT MARGI N ON ACCOUNT OF CAPACITY UTILIZATION, THE ADJUSTED PROFIT MARGIN OF THE ASSESSEE WOULD BE 0.93% AS AGAINST AVERAGE PROFIT MARGIN OF THE COMPARABLE COMPANIES OF 5.31%. IT WAS ALSO CLAIMED THAT THE DIFFERENCE BETWEEN THESE PROFIT MARGINS BEING LESS THAN 5%, NO TP ADJUSTMENT WAS REQUIRED TO BE MADE IN THE CASE OF ASSESSEE AS PER PROVISO TO SECTION 92C(2) OF THE ACT. I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 3 THE ADJUSTMENT CLAIMED BY THE ASSESSEE ON ACCOUNT O F CAPACITY UTILIZATION WAS NOT ALLOWED BY TPO BY RAISING CERTAIN DOUBTS ABOUT THE FIXED COST CLAIMED BY THE ASSESSEE. HE ALSO DID NOT ALLOW THE CLAIM OF THE ASSESSEE FOR THE BENEFIT OF 5% ADJUSTMENT HOLDING THAT SUCH BENEFIT COULD BE ALLOWED ONLY W HEN THE DIFFERENCE BETWEEN THE PROFIT MARGIN OF THE ASSESSEE AND THE PROFIT MARGIN OF TH E COMPARABLES IS WITHIN THE RANGE OF 5%. ACCORDINGLY, TAKING THE AVERAGE PROFIT MAR GIN OF 5.31% OF THE COMPARABLE COMPANIES AS ARMS LENGTH PROFIT, TP ADJUSTMENT OF RS.1,01,06,805/- WAS WORKED OUT BY THE TPO IN HIS ORDER PASSED U/S 92CA(3) OF THE A CT. 4. WHEN ADDITION ON ACCOUNT OF THE TP ADJUSTMENT O F RS.1,01,06,805/- WORKED OUT BY THE TPO WAS MADE BY AO TO THE TOTAL INCOME OF THE ASSESSEE IN HIS ASSESSMENT ORDER PASSED U/S 143(3) OF THE ACT, APPEAL WAS PRE FERRED BY THE ASSESSEE BEFORE THE LD. CIT(A) CHALLENGING THE SAID ADDITION. 5. DURING THE PROCEEDINGS BEFORE THE LD. CIT(A), FOLLOWING SUBMISSIONS WERE MADE ON BEHALF OF THE ASSESSEE: (I) THAT IT BEING A NEW COMPANY AND AS IT WAS ENTERING A NEW MARKET IT WAS IMPORTANT THAT THE PRODUCT HAD TO BE OF SUPERIOR WO RKMANSHIP AND DESIGN TO BE ACCEPTED BY THE CUSTOMERS. LIKE ANY OTHER NEW COM PANY, THE APPELLANT ALSO HAD A LOT OF TEETHING PROBLEMS WHERE THE PRODUCT WO ULD NEED TO BE MODIFIED TO SUIT THE FRENCH MARKET WHICH IS VERY FASHION AND Q UALITY CONSCIOUS. IN FACT, THE REPRESENTATIVES OF THE AE USED TO VISIT FOR CHECK ING THE QUALITY ON A REGULAR BASIS. THERE WERE QUITE A FEW TIMES WHEN THE PRODU CTS HAD TO BE RE- MADE/REPAIRED AFTER THE QUALITY CHECK. TO ADD TO IT, INSUFFICIENT ORDERS AND STRINGENT MARKET CONDITIONS RESULTED IN THE APPELLA NT COMPANYS INABILITY TO MAKE THE BENEFIT OF THE ECONOMIES OF SCALE AS THE FACTO RY WAS OPERATING MUCH BELOW 100% OF THE INSTALLED CAPACITY. THE ACTUAL PRODUCT ION WAS ONLY 55,629/- PIECES IN FINANCIAL YEAR (FY) 2006-07) UNDER CONSIDERATION AS COMPARED TO 153,938 PIECES, 152,536 PIECES, 137,746 PIECES IN FYS 2007 -08, 2008-09 AND 2009-10 RESPECTIVELY. THE MANPOWER WAS EMPLOYED COMMENSURA TE WITH THE INSTALLED CAPACITY AS THEY HAD TO BE TRAINED AND THEREFORE, IT INCURRED HIGH MANPOWER COST AND FIXED OVERHEADS WHICH LED TO HIGH PRODUCTI ON COST. IN VIEW OF IT BEING ONLY THE SECOND YEAR OF OPERATIONS, RE-MAKING COTS HAVING BEEN INCURRED, UNDER UTILIZATION OF CAPACITY, HIGH MANPOWER COSTS AND FI XED OVERHEADS, ETC, THE APPELLANT HAD INCURRED LOSS DURING THE FY RELEVANT TO THE ASSESSMENT YEAR UNDER CONSIDERATION; (I) THAT, HOWEVER, THE LATER YEARS THE APPELLANT COMP ANY HAS MANAGED TO ACHIEVE BREAK-EVEN POINT IN TERMS OF SALES AND HAS GOTTEN UP TO PAR IN TERMS OF I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 4 QUALITY. THIS FACT ALSO REFLECTS FROM THE FINANCIA L PERFORMANCE OF THE APPELLANT COMPANY IN LATER YEARS ; IN FY 2008-09, THE PBIT OF THE APPELLANT HAS INCREASED TO RS.68.01 LAKHS AND IN FY 2009-10 IT HAS FURTHE R INCREASED TO RS.214.64 LAKHS. (II) THAT AS THE APPELLANT, BEING A NEW COMPANY IN THE J EWELLERY MARKET IN FRANCE, IT WAS VERY IMPORTANT FOR THE APPELLANT TO ENSURE THAT ITS PRODUCTS WERE OF SUPERIOR CRAFTSMANSHIP AND IT DESIGNS WERE ACCEP TABLE TO THE CUSTOMERS AND ACCORDINGLY THERE WAS A LOT OF REWORKING/REMAKING I NVOLVED TO ENSURE THAT THE PRODUCTS MEET THE SPECIFIED QUALITY STANDARDS. FUR THER, THE APPELLANT WAS NOT OPERATING AT ITS FULL INSTALLED CAPACITY AND COULD NOT ABSORB ITS ENTIRE FIXED COSTS. THUS, IN VIEW OF IT BEING IN THE INITIAL PHASE OF B USINESS OPERATIONS, IT HAD INCURRED LOSS. (III) THAT IN VIEW OF THE ABOVE ABNORMAL PHASE OF ITS BUS INESS AND LARGE FIXED COSTS SITTING IN THE BOOKS OF ACCOUNT, AND IN ORDER TO BRING OUT THE CORRECT PICTURE OF ITS OPERATIONAL ACTIVITIES, IT IS NECESS ARY TO MAKE CERTAIN ECONOMIC ADJUSTMENTS TO CERTAIN COSTS WHILE DETERMINING THE OPERATING MARGIN OF THE APPELLANT. THE APPELLANT SUBMITS THAT CERTAIN EXP ENSES, SUCH CASE, LEASE RENT CHARGES, RATES AND TAXES AND WATER CHARGES, PROCESS ING CHARGES, EMPLOYEE COST, MISCELLANEOUS EXPENSES AND DEPRECIATION WOULD BE CO NSIDERED AS FIXED COST BECAUSE THERE ARE NO MATERIAL OR SIGNIFICANT CHANG ES IN THESE EXPENSES IN THE FUTURE YEARS I.E. FY 2006-07, 2007-08 AND 2008-09 A S COMPARED TO THE ACTUAL PRODUCTION OF JEWELRY IN TERMS OF UNITS PRODUCED IN EACH OF THESE THREE YEARS . 6. AFTER CONSIDERING THE SUBMISSIONS MADE ON BEHAL F OF THE ASSESSEE AS WELL AS MATERIAL AVAILABLE ON RECORD, THE LD. CIT(A) UPHELD THE ACTION OF THE AO IN DISALLOWING THE ASSESSEES CLAIM FOR ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION HOLDING THAT ALTHOUGH THESE FACTORS MIGHT HAVE CONTRIBUTED TO T HE LOSS OF THE ASSESSEE COMPANY, IT COULD NOT BE ARRIVED AT WITH ANY DEGREE OF CERTAIN TY THAT THE TRANSFER PRICE OF THE INTERNATIONAL TRANSACTION HAVE CONTRIBUTED TOWARDS THE LOSS OF THE ASSESSEE COMPANY IN THE ABSENCE OF ANY DETAILS FURNISHED BY THE ASS ESSEE COMPANY REGARDING THE PRICE AT WHICH THE FINAL PRODUCT WAS SOLD BY THE AE. TH E CLAIM OF THE ASSESSEE QUA THE BENEFIT OF 5% ADJUSTMENT AS PER SECOND PROVISO TO SECTION 92C(2) OF THE ACT, HOWEVER, WAS ALLOWED BY THE LD. CIT(A) KEEPING IN VIEW THE VARIOUS CASE LAWS CITED ON BEHALF OF THE ASSESSEE. AGGRIEVED BY THE ORDER OF LD. CIT( A), THE REVENUE HAS PREFERRED THIS APPEAL BEFORE THE TRIBUNAL DISPUTING THE BENEFIT OF 5% ADJUSTMENT ALLOWED BY LD. CIT(A) WHILE THE ASSESSEE HAS ALSO FILED THE CROSS -OBJECTION CHALLENGING THE ORDER OF THE LD. CIT(A) CONFIRMING THE ACTION OF AO/TPO IN NOT ALLOWING ITS CLAIM FOR ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION. I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 5 7. WE HAVE HEARD THE ARGUMENTS OF BOTH THE SIDES AND ALSO PERUSED THE MATERIAL AVAILABLE ON RECORD. AS REGARDS THE ISSUE INVOLVED IN THE APPEAL OF THE REVENUE RELATING TO THE BENEFIT OF 5% ADJUSTMENT ALLOWED BY LD. CI T(A) AS PER PROVISO TO SECTION 92C(2) OF THE ACT, IT IS OBSERVED THAT THE SAME IS SQUARELY COVERED IN FAVOUR OF THE ASSESSEE INTER ALIA BY THE FOLLOWING DECISIONS OF T HE TRIBUNAL : A) AMDOCS BUSINESS SERVICES (P) LTD V/S DCIT IN IT APPEAL NO.1412 (PUNE) OF 2011 DATED J ULY 23,2012 (AY-2007-08); B) STARENT NETWORKS (INDIA) P.LTD V/S DCIT IN ITA NO.1350/PN/2010, (AY-2006-07) ORDER DATED 3.10.2011; C) TATA VECTRA MOTORS LTD V/S DCIT IN IT APPE AL NO.1284(BANG) OF 2010 DATED JANUARY 31,2012 (AY-2006-07) D) M/S IPOLICY NETWORK PVT LTD V/S ITO IN ITA NO.55 04/DEL/2010 (AY-2006-07) DATED 17.6.2011. 8. IN ONE OF THE DECISIONS RENDERED IN THE CASE OF STARENT NETWORKS (INDIA) P.LTD (SUPRA), THE TRIBUNAL HAS CONSIDERED AND DISCUSSED ALL THE RELEVANT ASPECTS OF THE MATTER, WHILE ALLOWING THE CLAIM OF THE ASSESSEE F OR THE BENEFITS OF 5% ADJUSTMENT AS PER THE PROVISO TO SECTION 92C(2) OF THE ACT AS PRE VALENT AT THE RELEVANT POINT OF TIME, IN PARAS 20 TO 23 OF THE ORDER WHICH READ AS UNDER : 20. WE HAVE CAREFULLY CONSIDERED THE RIVAL SUBMISS IONS. IN THIS CASE, A PERTINENT ISSUE WHICH HAS BEEN VEHEMENTLY AGITATED BY THE APPELLANT IS WITH REGARD TO ITS CLAIM OF SEEKING BENEFIT OF THE OPTION AVAILABLE UNDER THE ERSTWHILE PROVISO TO SECTION 92C(2) OF THE ACT. THE ERSTWHILE PROVISO WHICH WAS INSERTED BY FINANCE ACT, 2002 WITH EFFECT FROM 1.4.2002 READ AS UNDER: 'PROVIDED THAT WHERE MORE THAN ONE PRICE IS DETERMI NED BY THE MOST APPROPRIATE METHOD, THE ARM'S LENGTH PRICE SHA LL BE TAKEN TO BE THE ARITHMETICAL MEAN OF SUCH PRICES, OR, AT THE OPTION OF THE ASSESSEE, A PRICE WHICH MAY VARY FROM THE ARITHMETI CAL MEAN BY AN AMOUNT NOT EXCEEDING FIVE PERCENT OF SUCH ARITHMETI CAL MEAN.' AS PER THE SAID PROVISO, AN OPTION IS AVAILABLE TO THE ASSESSEE FOR ADJUSTMENT OF +/-5% VARIATION FOR THE PURPOSES OF C OMPUTING ALP. AS PER THE PROVISO, WHERE MORE THAN ONE PRICE IS DETERMINE D BY THE MOST APPROPRIATE METHOD, THE ARM'S LENGTH PRICE SHALL BE TAKEN TO BE THE ARITHMETICAL MEAN OF SUCH PRICES OR AT THE OPTION O F THE ASSESSEE, A PRICE WHICH MAY VARY FROM THE ARITHMETICAL MEAN BY AN AMO UNT NOT EXCEEDING 5% OF SUCH ARITHMETICAL MEAN. THE POINT MADE OUT BY THE ASSESSEE IS BASED ON THE LATTER PART OF THE PROVISO WHEREBY AN OPTION IS GIVEN TO THE I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 6 ASSESSEE TO TAKE AN ALP WHICH MAY VARY FROM THE ARI THMETICAL MEAN BY AN AMOUNT NOT EXCEEDING 5% OF SUCH ARITHMETICAL MEAN. FIRSTLY, THE CLAIM OF THE REVENUE IS THAT SUCH BENEFIT IS NOT AVAILABLE T O THE PRESENT ASSESSEE, BECAUSE THE PRICE OF INTERNATIONAL TRANSACTION DISC LOSED BY THE ASSESSEE EXCEEDS THE MARGIN PROVIDED IN THE PROVISO. THIS AS PECT OF THE CONTROVERSY, IN OUR VIEW, IS NO LONGER GERMANE IN V IEW OF THE PLETHORA OF DECISIONS OF OUR CO-ORDINATE BENCHES, NAMELY, SONY INDIA (P) LTD. (SUPRA); ELECTROBUG TECHNOLOGIES LTD. (SUPRA), AND DEVELOPME NT CONSULTANT P LTD V DCIT 115 TTJ 577 (KOL.) WHEREIN IT HAS BEEN OBSER VED THAT THE BENEFIT OF THE OPTION CONTAINED IN THE LATTER PART OF THE P ROVISO TO SECTION 92C(2) IS AVAILABLE TO ALL ASSESSEES, IRRESPECTIVE OF THE FACT THAT PRICE OF THE INTERNATIONAL TRANSACTION DISCLOSED BY THEM EXCEEDS THE MARGIN PRESCRIBED IN THE PROVISO. 21. SO, HOWEVER, THE OTHER ARGUMENT SET UP BY THE R EVENUE AND WHICH HAS BEEN MORE POTENTLY ARGUED IS TO THE EFFECT THAT THE BENEFIT OF SUCH PROVISO IS NOT AVAILABLE TO THE ASSESSEE IN THE INS TANT CASE, BECAUSE THE SAID PROVISO HAS BEEN AMENDED BY THE FINANCE (NO 2) ACT, 2009 WITH EFFECT FROM 1.10.2009 WHICH READS AS UNDER: 'PROVIDED THAT WHERE MORE THAN ONE PRICE IS DETERMI NED BY THE MOST APPROPRIATE METHOD, THE ARM'S LENGTH PRICE SHA LL BE TAKEN TO BE THE ARITHMETICAL MEAN OF SUCH PRICES: PROVIDED F URTHER THAT IF THE VARIATION BETWEEN THE ARM'S LENGTH PRICE SO DETERMI NED AND PRICE AT WHICH THE INTERNATIONAL TRANSACTION HAS ACTUALLY BE EN UNDERTAKEN DOES NOT EXCEED FIVE PER CENT OF THE LATTER, THE PR ICE AT WHICH THE INTERNATIONAL TRANSACTION HAS ACTUALLY BEEN UNDERTA KEN SHALL BE DEEMED TO BE THE ARM'S LENGTH PRICE.' THE CASE SET UP BY THE REVENUE IS THAT THE AMENDED PROVISO SHALL GOVERN THE DETERMINATION OF ALP IN THE PRESENT CASE, INASM UCH AS THE AMENDED PROVISIONS WERE ON STATUTE WHEN THE PROCEEDINGS WER E CARRIED ON BY THE TRANSFER PRICING OFFICER (TPO). AS PER THE REVENUE, THE AMENDED PROVISO WOULD HAVE A RETROSPECTIVE OPERATION AND IN ANY CAS E, WOULD BE APPLICABLE TO THE PROCEEDINGS WHICH ARE PENDING BEFORE THE TPO ON INSERTION OF THE AMENDED PROVISO, WHICH HAS BEEN INSERTED BY THE FIN ANCE (NO. 2) ACT, 2009 WITH EFFECT FROM 1.10.2009 AND, IN THIS CASE, THE TPO HAS PASSED HIS ORDER ON 30.10.2009. THE LEARNED DEPARTMENTAL REPRE SENTATIVE HAS ALSO REFERRED TO THE CBDT CIRCULAR NO 5/2010 (SUPRA) REA D WITH CORRIGENDUM DATED 30.9.2010 ISSUED BY THE CBDT IN THIS REGARD. PER CONTRA, THE STAND OF THE ASSESSEE IS THAT THE AMENDED PROVISO WOULD B E APPLICABLE PROSPECTIVELY AND WOULD NOT APPLY IN RESPECT OF THE STATED ASSESSMENT YEAR, WHICH IS PRIOR TO THE INSERTION OF THE AMENDE D PROVISO WITH EFFECT FROM 1.10.2009. 22. WE HAVE CAREFULLY EXAMINED THE RIVAL STANDS ON THIS ASPECT. THE AMENDED PROVISO HAS BEEN BROUGHT ON THE STATUTE BY THE FINANCE (NO. 2) ACT, 2009 WITH EFFECT FROM 1.10.2009. THE EXPLANATO RY NOTES TO THE PROVISIONS OF FINANCE (NO 2) ACT, 2009 CONTAINED IN CIRCULAR NO 5 OF 2010 I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 7 (SUPRA) PROVIDES THE OBJECTIVE BEHIND THE AMENDMENT OF THE PROVISO. THE LEGISLATURE NOTICED THE CONFLICTING INTERPRETATION OF THE ERSTWHILE PROVISO BY THE ASSESSEE AND THE INCOME-TAX DEPARTMENT. THE ASSESSEE'S VIEW WAS THAT THE ARITHMETICAL MEAN SHOULD BE ADJUSTED BY 5% TO ARRIVE AT ALP, WHEREAS THE DEPARTMENTAL VIEW WAS THAT NO SUCH ADJU STMENT IS REQUIRED TO BE MADE IF THE VARIATION BETWEEN THE TRANSFER PR ICE AND THE ARITHMETICAL MEAN IS MORE THAN 5% OF THE ARITHMETICAL MEAN. WITH A VIEW TO RESOLVING THIS CONTROVERSY, THE LEGISLATURE SOUGHT TO AMEND T HE PROVISO TO SECTION 92C(2), WHICH HAS BEEN REPRODUCED BY US IN THE EARL IER PART OF THIS ORDER. IN THE SAID CIRCULAR, IT HAS ALSO BEEN ELABORATED T HAT THE ABOVE AMENDMENT HAS BEEN MADE APPLICABLE WITH EFFECT FROM 1.4.2009 AND WILL ACCORDINGLY APPLY IN RESPECT OF ASSESSMENT YEAR 200 9-10 AND SUBSEQUENT YEARS. IN ANY CASE, THE PROVISO CONTAINS A PRESCRIP TION TO DETERMINE THE ALP AND QUITE CLEARLY IT IS A SUBSTANTIVE PROVISION ENCOMPASSING THE EVENTUAL DETERMINATION OF AN ASSESSEE'S TAX LIABILI TY. THUS, IT CAN BE SAID THAT THE PROVISO IS NOT A PROCEDURAL PIECE OF LEGIS LATION AND THEREFORE, UNLESS IT IS SO CLEARLY INTENDED, THE NEWLY AMENDED PROVISO CANNOT BE UNDERSTOOD TO BE RETROSPECTIVE IN NATURE. IN FACT, IT IS A WELL-SETTLED PROPOSITION THAT THE STATUTORY PROVISIONS AS THEY S TAND ON THE FIRST DAY OF APRIL OF THE ASSESSMENT YEAR MUST APPLY TO THE ASSE SSMENT OF THE YEAR AND THE MODIFICATION OF THE PROVISIONS DURING THE P ENDENCY OF ASSESSMENT WOULD NOT GENERALLY PREJUDICE THE RIGHTS OF THE ASS ESSEE. FURTHERMORE, WE ARE FORTIFIED BY THE INTENTION OF THE LEGISLATURE A S FOUND FROM CIRCULAR NO 5 OF 2010 (SUPRA) WHEREBY IN PARA 37.5, THE APPLICABI LITY OF THE ABOVE AMENDMENT HAS BEEN STATED TO BE WITH EFFECT FROM 1. 4.2009 SO AS TO APPLY IN RESPECT OF ASSESSMENT YEAR 2009-10 AND SUB SEQUENT YEARS. IN THIS REGARD, WE ALSO FIND THAT THE DELHI BENCH OF T HE TRIBUNAL IN THE CASE OF ACIT V UE TRADE CORPORATION INDIA (P) LTD. VIDE ITA NO 4405(DEL)/2009 DT 24.12.2010 HAS OBSERVED THAT THE PROVISO INSERTE D BY THE FINANCE (NO 2) ACT, 2009 WOULD NOT APPLY TO AN ASSESSMENT YEAR PRIOR TO ITS INSERTION. IN THIS VIEW OF THE MATTER, WE THEREFORE FIND NO JU STIFICATION TO DENY THE BENEFIT OF +/-5% TO THE ASSESSEE IN TERMS OF THE ER STWHILE PROVISO FOR THE PURPOSES OF COMPUTING THE ALP. 23. HOWEVER, BEFORE PARTING WE MAY ALSO REFER TO A CORRIGENDUM DATED 30.9.2010 BY THE CBDT BY WAY OF WHICH PARA 37.5 OF THE CIRCULAR NO 5/2010 (SUPRA) HAS BEEN SOUGHT TO BE MODIFIED. THE CORRIGENDUM READS AS UNDER: 16 ' CORRIGENDUM IN PARTIAL MODIFICATION OF CIRCULAR NO. 5/2010 DATE D 03.6.2010, (I) IN PARA 37.5 OF THE SAID CIRCULAR, FOR THE LIN ES ST 'THE ABOVE AMENDMENT HAS BEEN MADE APPLICABLE WITH EFFECT FROM 1 APRIL, 2009 AND WILL ACCORDINGLY APPLY IN RESPECT OF ASSESSMENT YEAR 2009-10 AND SUBSEQUENT YEARS.' I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 8 THE FOLLOWING LINES SHALL BE READ; 'THE ABOVE AMENDMENT HAS BEEN MADE APPLICABLE WITH EFFECT FROM 1 OCTOBER, 2009 AND SHALL ACCORDINGLY APPLY IN RELA TION TO ALL CASES IN WHICH PROCEEDINGS RE PENDING BEFORE THE TRANSFER PRICING OFFICER (TPO) ON OR AFTER SUCH DATE.' (II) IN PARA 38.3, FOR THE DATE '1 OCTOBER, 2009, T HE FOLLOWING DATE SHALL BE READ: '1 APRIL, 2009'. IN TERMS THEREOF, IT IS CANVASSED THAT THE AMENDED PROVISO HAS BEEN MADE APPLICABLE WITH EFFECT FROM 1.10.2009 AND SHALL APP LY EVEN TO CASES WHERE PROCEEDINGS WERE PENDING BEFORE THE TPO ON OR AFTER SUCH DATE, IRRESPECTIVE OF THE ASSESSMENT YEAR INVOLVED AND, T HEREFORE, IN THE INSTANT CASE THE BENEFIT OF THE ERSTWHILE PROVISO CANNOT BE EXTENDED TO THE ASSESSEE. WE HAVE CAREFULLY PONDERED OVER THE ASSER TION MADE BY THE APPELLANT THAT THE CORRIGENDUM IS UNTENABLE IN THE EYES OF LAW. FIRSTLY, THE SAID CORRIGENDUM DOES NOT BRING OUT ANY PREAMBLE SO AS TO THROW LIGHT ON THE CIRCUMSTANCES AND THE BACKGROUND IN WHICH THE S AME HAS BEEN ISSUED. SECONDLY, IT IS WELL UNDERSTOOD THAT THE EX PLANATORY NOTES TO THE PROVISIONS OF A FINANCE ACT PASSED BY THE PARLIAMEN T SEEKS TO EXPLAIN THE SUBSTANCE OF THE PROVISIONS OF THE ACT AS INTENDED BY THE LEGISLATURE. IN FACT, THE HON'BLE SUPREME COURT IN THE CASE OF K.P VARGHESE V ITO 131 ITR 597 (KER) EMPHASIZED THE SANCTITY OF THE STATEM ENTS CONTAINED IN THE EXPLANATORY NOTES OF THE PROVISIONS AND STATED THAT THE INTERPRETATION PLACED IN SUCH DOCUMENTS IS BINDING INTERPRETATION OF LAW. THE CONTENTS OF THE CORRIGENDUM ARE QUITE INEXPLICABLE. NOTWITHSTAN DING THE AFORESAID AND WITHOUT GOING INTO THE VALIDITY OF THE CORRIGENDUM DATED 30.9.2010 (SUPRA), WE ARE OF THE VIEW THAT THE SAME WOULD NOT OPERATE TO THE DETRIMENT OF THE ASSESSEE SINCE AT THE RELEVANT POI NT OF TIME THE CONTENTS OF THE CIRCULAR NO 5/2010 (SUPRA) WERE IN OPERATION . IN OTHER WORDS, THE WITHDRAWAL OF THE INTERPRETATION PLACED IN CIRCULAR NO 5 /2010 (SUPRA) ON THE APPLICABILITY OF THE AMENDED PROVISO IS SOUGHT TO BE DONE AWAY BY THE CORRIGENDUM DATED 30.9.2010 AND, THEREFORE, SUCH WI THDRAWAL SHALL BE EFFECTIVE ONLY AFTER 30.9.2010, EVEN IF SUCH CORRIG ENDUM IS ACCEPTED AS VALID. WE MAY NOTE HERE THAT THE APPELLANT HAS ASSA ILED THE VALIDITY OF THE CORRIGENDUM ITSELF ON WHICH WE HAVE NOT MADE ANY DE TERMINATION. THEREFORE, THE CORRIGENDUM DATED 30.9.2010, IN OUR CONSIDERED OPINION, HAS NO BEARING SO AS TO DIS-ENTITLE THE ASSESSEE FR OM ITS CLAIM OF THE BENEFIT OF +/-5% IN TERMS OF THE ERSTWHILE PROVISO TO SECTION 92C(2) OF THE ACT. IN COMING TO THE AFORESAID, WE HAVE BEEN GUIDE D BY THE PARITY OF REASONING LAID DOWN IN THE JUDGMENTS OF THE HON'BLE BOMBAY HIGH COURT IN THE CASES OF BASF (INDIA) LTD. V CIT 280 ITR 136 (BOM); SHAKTI RAJ FILMS DISTRIBUTORS V CIT 213 ITR 20 (BOM); AND, UNI T TRUST OF INDIA & ANRS. V ITO 249 ITR 612 (BOM). THE HON'BLE HIGH COU RT HAS OPINED IN THE CASE OF BASF (INDIA) LTD. (SUPRA) THAT THE CIRCULAR S WHICH ARE IN FORCE DURING THE RELEVANT PERIOD ARE TO BE APPLIED AND TH E SUBSEQUENT CIRCULARS EITHER WITHDRAWING OR MODIFYING THE EARLIER CIRCULA RS HAVE NO APPLICATION. MOREOVER, THE CIRCULARS IN THE NATURE OF CONCESSION CAN BE WITHDRAWN I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 9 PROSPECTIVELY ONLY AS HELD BY THE HON'BLE SUPREME C OURT IN THE CASE OF STATE BANK OF TRAVANCORE V CIT 50 CTR 102 (SC). CON SIDERING ALL THESE ASPECTS, WE THEREFORE FIND NO JUSTIFICATION IN THE ACTION OF THE LOWER AUTHORITIES IN DISENTITLING THE ASSESSEE FROM ITS C LAIM FOR THE BENEFIT OF +/- 5% TO COMPUTE ALP IN TERMS OF THE ERSTWHILE PROVISO TO SECTION 92C(2) OF THE ACT. WE ORDER ACCORDINGLY. 9. ON THE ABOVE LINES, THE TRIBUNAL IN OTHER CASES ALSO HAS DECIDED A SIMILAR ISSUE IN FAVOUR OF THE ASSESSEE WHILE ALLOWING THE BENEFI T OF 5% TO THE ASSESSEE AS PER THE ERSTWHILE PROVISO TO 92C OF THE ACT. THE ISSUE INV OLVED IN THE PRESENT CASE IN REVENUES APPEAL THUS IS SQUARELY COVERED IN FAVOUR OF THE ASSESSEE BY THESE DECISIONS OF THE TRIBUNAL AND RESPECTFULLY FOLLOWING THE SAME, WE U PHOLD THE ORDER OF LD. CIT(A) ALLOWING THE BENEFIT OF 5% ADJUSTMENT TO THE ASSES SEE WHILE COMPUTING THE TP ADJUSTMENT. 10. AS REGARDS THE ISSUE INVOLVED IN THE CROSS-OBJ ECTION FILED BY THE ASSESSEE RELATING TO THE CLAIM OF THE ASSESSEE FOR ADJUSTMEN T ON ACCOUNT OF CAPACITY UTILIZATION, IT IS OBSERVED THAT THE SAID CLAIM OF THE ASSESSEE WAS DISALLOWED BY THE AO AS WELL AS BY LD. CIT(A) ON ACCOUNT OF IRRELEVANT CONSIDERATION. IN THE CASE OF DCIT V/S PETRO ARALDITE (P) LTD, THE CO-ORDINATE BENCH OF THE TR IBUNAL HAS DECIDED THE SIMILAR ISSUE VIDE ITS ORDER DATED JULY 24, 2013 PASSED IN IT AP PEAL NO.3782 (MUM) OF 2011 (AY 2005-06), AFTER CONSIDERING AND DISCUSSING THE NECE SSITY OF ALLOWING ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION WHILE COMPUTING TH E TP ADJUSTMENT. THE TRIBUNAL HAS EXPLAINED HOW SUCH ADJUSTMENT IS NECESSARY DEPENDIN G ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND HAS ALSO LAID DOWN THE GUIDELINES A S TO HOW TO QUANTIFY SUCH ADJUSTMENT. THE OBSERVATIONS RECORDED BY THE TRIB UNAL IN THIS CONTEXT IN PARAS 19 TO 25 OF ITS ORDER ARE REPRODUCED BELOW : 19. THERE BEING DIFFERENCE IN THE CAPACITY UTILIZA TION OF THE ASSESSEE VIS-- VIS THE COMPARABLES, ADJUSTMENT ON ACCOUNT OF CAPAC ITY UTILIZATION WAS CLAIMED BY THE ASSESSEE. ACCORDING TO THE ASSESSEE, IF THE PROFIT MARGIN IS TAKEN BEFORE DEPRECIATION BY ADOPTING EARNING BEFOR E DEPRECIATION, INTEREST AND TAX (EBDIT) AS PLI, THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFIT MARGIN CAN BE NULLIFIED. THE TPO DID NOT APP ROVE THIS METHOD ADOPTED I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 10 BY THE ASSESSEE FOR MAKING ADJUSTMENT ON ACCOUNT OF CAPACITY UTILIZATION WHEREAS THE LD. CIT(A) FOUND THE SAME TO BE ACCEPTA BLE HOLDING THAT THE UNDER UTILIZATION OF CAPACITY RESULTS IN UNDER RECO VERY OF FIXED EXPENSES LIKE DEPRECIATION AND IF THE DEPRECIATION IS EXCLUDED, T HE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON PROFIT MARGIN CAN BE NULLIF IED. BEFORE WE PROCEED TO DEAL WITH THE ISSUE OF ADJUSTMENT FOR DIFFERENCE IN CAPACITY UTILIZATION, IT IS NECESSARY FIRST TO SEE THE PROCEDURE LAID DOWN FOR CARRYING OUT THE EXERCISE OF COMPARABILITY ANALYSIS AND MAKING SUITABLE ADJUS TMENTS. THIS PROCEDURE AS LAID DOWN IN SECTION 92-C OF THE ACT PROVIDES TH AT THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION SHALL BE DETERMINED BY AN Y OF THE METHODS SPECIFIED THEREIN, BEING THE MOST APPROPRIATE METHO D 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 STIPULAT ES THE MANNER IN WHICH THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION IS TO BE DETERMINED BY FOLLOWING THE TRANSACTIONAL NET MARGIN METHOD AS UN DER: '( E ) TRANSACTIONAL NET MARGIN METHOD, BY WHICH, ( I ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE FR OM A N INTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSO CIATED 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 MA RGIN REALISED BY THE ENTERPRISE OR BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED 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 - CLAUSE (II) ARISING IN C OMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES, IF ANY, BETWEEN THE INTERN ATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSAC TIONS, OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACT IONS, WHICH COULD MATERI ALLY AFFECT THE AMOUNT OF NET PROFIT MARGIN IN THE OPEN MARKET; ( IV ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE AN D 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 NE T PROFIT MARGIN THUS ESTABLISHED IS THEN TAKEN INTO ACCOUNT TO ARRIVE AT AN ARM'S LENGTH PRICE IN RELAT ION TO THE INTERNATIONAL TRANSACTION;' 20. KEEPING IN VIEW THE AFORESAID 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 A PPROPRIATELY BE MADE WITHIN THE FRAMEWORK OF RULE 10B. THE ISSUE OF DIFF ERENCE IN CAPACITY I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 11 UTILISATION GENERALLY COMES IN THE CASE OF MANUFACT URING CONCERN AND LIKE ANY OTHER BUSINESS UNDERTAKING, THE MANUFACTURING C ONCERN HAS MAINLY TWO TYPES OF OVERHEADS I.E. FIXED OVERHEADS AND VAR IABLE OVERHEADS. THE VARIABLE OVERHEADS VARY IN PROPORTION TO THE SALES AND THEY THEREFORE DO NOT HAVE ANY EFFECT ON THE PROFIT MARGIN AS A RESUL T OF DIFFERENCE IN CAPACITY UTILIZATION. THE FIXED OVERHEADS, ON THE O THER HAND, DO NOT VARY WITH THE VOLUME OF SALES AND SINCE THEY REMAIN BY A ND LARGE STATIC IRRESPECTIVE OF LEVEL OF CAPACITY UTILIZATION, THE PROFIT MARGIN GETS AFFECTED AS A RESULT OF DIFFERENCE IN CAPACITY UTILIZATION O N THIS COUNT. THE UNDER UTILIZATION OF CAPACITY RESULTS IN OVER ALLOCATION OR OVER ABSORPTION OF FIXED OVERHEADS RESULTING INTO UNDER-RECOVERY OF FIXED OV ERHEADS WHICH ADVERSELY AFFECTS THE PROFIT MARGIN. AS THE LEVEL O F CAPACITY UTILIZATION GOES UP, THE RATE OF ALLOCATION OR ABSORPTION OF FIXED O VERHEADS TO SALES COMES DOWN RESULTING INTO HIGHER PROFIT MARGIN. THE FOLLO WING SIMPLE EXAMPLE WOULD FURTHER EXPLAIN THIS POSITION: INSTALLED CAPACITY IN MONETARY TERMS RS.10 CRORES RS. 10 CRORES RS. 10 CRORES CAPACITY UTILISATION 50% 60% 80% SALES RS. 5 CRORES RS. 6 CRORES RS.8 CRORES VARIABLE OVERHEADS AT 50% RS.2.5 CRORES RS.3 CRORES RS. 4 CRORES FIXED OVERHEADS RS.2 CRORES RS. 2 CRORES RS. 2 CROR ES NET PROFIT RS.0.5 CRORES RS. 1 CRORE RS. 2 CRORES PROFIT MARGIN (OP/SALES) 10% 16.67% 25% 21. THE ABOVE EXAMPLE SHOWS THAT THE PROFITABILITY CHANGES WITH THE CHANGE IN THE LEVEL OF CAPACITY UTILIZATION WITH HI GHER PROFITABILITY AT HIGHER UTILIZATION AND LOWER PROFITABILITY AT LOWER REALIZ ATION. THIS HAPPENS MAINLY BECAUSE OF HIGHER ALLOCATION OR ABSORPTION OF FIXED OVERHEADS AT LOWER CAPACITY UTILIZATION WHICH COMES DOWN AS THE LEVEL OF CAPACITY UTILIZATION GOES UP. FOR INSTANCE, AS GIVEN IN THE ABOVE EXAMPL E, THE RATE OF ALLOCATION OR ABSORPTION OF FIXED OVERHEADS TO SALE S IS 40% AT 50% CAPACITY UTILIZATION WHILE IT BECOMES 33.33% AT 60% CAPACITY UTILIZATION AND 25% AT 80% CAPACITY UTILIZATION GIVING MORE PRO FIT MARGIN OF 16.67% AT 60% CAPACITY UTILIZATION AND 25% AT 80% CAPACITY UTILIZATION AS AGAINST PROFIT MARGIN OF 10% AT 50% CAPACITY UTILIZATION. T HE DIFFERENCE IN CAPACITY UTILIZATION THUS MATERIALLY AFFECTS THE PR OFIT MARGIN AND IF THERE IS A DIFFERENCE IN THE LEVEL OF CAPACITY UTILIZATION O F THE ASSESSEE AND THE LEVEL OF CAPACITY UTILIZATION OF THE COMPARABLE COM PANIES, ADJUSTMENT IS REQUIRED TO BE MADE TO THE PROFIT MARGIN OF THE COM PARABLES 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 ADOPTIO N OF PROPER METHOD BY WHICH THE SAME CAN APPROPRIATELY BE MADE. IN THE PR ESENT CASE, THE ASSESSEE MADE THIS ADJUSTMENT BY NOT CONSIDERING DE PRECIATION FOR I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 12 COMPUTING ITS OWN OPERATING PROFIT AS WELL AS THE O PERATING PROFIT OF COMPARABLE. IT WAS DONE BY TAKING EBDIT AS PLI INST EAD OF EBIT. ALTHOUGH THIS METHOD ADOPTED BY THE ASSESSEE WAS NO T APPROVED BY THE TPO, IT WAS ACCEPTED BY THE LD. CIT(A) ON THE GROUN D 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 CONC UR WITH THIS VIEW OF THE LD. CIT(A). IN OUR OPINION, WHEN THE PLI IS TAK EN AS OP TO SALES OR OP TO COST, OPERATING PROFIT OF THE ASSESSEE AS WELL A S COMPARABLE CASES BECOMES RELEVANT AND THE DEPRECIATION BEING VERY MU CH INTEGRAL PART OF THE OPERATING EXPENSES OF THE MANUFACTURING CONCERN , THE SAME CANNOT BE EXCLUDED FOR THE PURPOSE OF COMPUTING OPERATING 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 CL AUSE (E)(II) OF THE SAID SUB RULE REQUIRES THAT NET PROFIT MARGIN OF THE COM PARABLES IS WORKED OUT. CLAUSE (E)(III), WHICH PERMITS THE ADJUSTMENTS, CLE ARLY STIPULATES THAT ANY ADJUSTMENT ON ACCOUNT OF DIFFERENCES AFFECTING MATE RIALLY THE PROFITABILITY IS TO BE MADE TO THE NET PROFIT MARGIN OF THE COMPA RABLES AS REFERRED TO IN CLAUSE (E)(II). BY TAKING THE NET PROFIT MARGIN OF THE ASSESSEE WITHOUT CONSIDERING THE DEPRECIATION IN ORDER TO MAKE ADJUS TMENT ON ACCOUNT OF DIFFERENCE IN CAPACITY UTILIZATION, WHAT THE ASSESS EE HAS SOUGHT TO DO IS TO MAKE ADJUSTMENT TO THE NET PROFIT MARGIN OF THE ASS ESSEE 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 S UB RULE (1) OF RULE 10B. 23. THE QUESTION THAT NOW ARISES IS WHAT IS THE PRO PER METHOD OF MAKING ADJUSTMENT FOR DIFFERENCE IN CAPACITY UTILIZATION W ITHIN THE FRAME WORK GIVEN IN RULE 10B. AS ALREADY DISCUSSED BY US, THE DIFFERENCE IN CAPACITY UTILIZATION AFFECTS THE PROFITABILITY MAINLY BECAUS E OF THE DIFFERENCE IN RATES AT WHICH THE FIXED OVERHEADS ARE ABSORBED OR ALLOCA TED DEPENDING ON THE LEVEL OF CAPACITY UTILIZATION. THE EXAMPLE GIVEN BY US CLEARLY DEPICTS THIS POSITION. THE SAID EXAMPLE SHOWS THAT THE ALLOCATIO N 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 A BSORPTION OF COMPARABLE IS BROUGHT AT THE LEVEL OF THE ASSESSEE , IT WOULD NULLIFY THE EFFECT OF DIFFERENCE IN CAPACITY UTILIZATION ON THE PROFIT MA RGIN. FOR EXAMPLE, IF WE TAKE THE PROFITABILITY WORKING AT 50% CAPACITY UTIL IZATION 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 FI XED OVERHEADS OF THE COMPARABLES IN ORDER TO BRING THE SAME AT PAR (I.E. 40% OF SALES) WITH THE TESTED PARTY, THE RESULTANT POSITION WILL BE AS UND ER:- 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 CRORES RS.1.20 CRORES NET PROFIT AFTER ADJUSTMENT RS. 0.60 CRORES RS. 0.80 CRORES PROFIT MARGIN AFTER ADJUSTMEN T 10% 10% I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 13 24. THE ADJUSTMENT THUS CAN BE MADE TO THE PROFIT M ARGIN OF THE COMPARABLES BY ALLOCATING FIXED OVERHEADS AT THE SA ME RATE AT WHICH FIXED OVERHEADS ARE ALLOCATED IN THE CASE OF THE TESTED P ARTY. FOR EXAMPLE, IN THE CASE OF A COMPARABLE HAVING 80% CAPACITY UTILIZ ATION, THE RATE OF ALLOCATION OF DEPRECIATION IS 25% OF THE SALES AS A GAINST 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 T HE TESTED PARTY, THE PROFIT OF THE COMPARABLE WOULD BE REDUCED BY RS. 1.20 CROR ES 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. SIMILARLY, IF TH E ADJUSTMENT IS MADE IN THE PROFIT MARGIN OF A COMPARABLE HAVING 60% CAPACITY U TILIZATION BY ALLOCATING MORE FIXED OVERHEADS AT 6.67% OF SALES T O BRING THE RATE OF ALLOCATION OF FIXED OVERHEADS AT PAR WITH THAT OF T HE TESTED PARTY, THE PROFIT OF THE SAID COMPARABLE WOULD BE REDUCED BY RS. 0.40 CRORES THEREBY GIVING 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 DIFF ERENCE IN CAPACITY UTILIZATION IS REQUIRED TO BE MADE AND HAVING EXPLA INED WITH ILLUSTRATION THAT THE SAME CAN APPROPRIATELY BE MADE BY ABSORBIN G OR ALLOCATING FIXED OVERHEADS SUCH AS DEPRECIATION ON SALES OF THE COMP ARABLE AT THE SAME RATE AS THAT OF THE TESTED PARTY, WE ARE OF THE VIE W THAT SUCH ABSORPTION OR ALLOCATIONS OF FIXED OVERHEADS 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 FI NISHED GOODS, IF ANY, OF THE TESTED PARTY AND COMPARABLES . 11. KEEPING IN VIEW THE DECISION OF THE TRIBUNAL I N THE CASE OF PETRO ARALDITE (P) LTD (SUPRA) LAYING DOWN THE GUIDELINES ON THE ISSUE OF CAPACITY UTILIZATION, WE CONSIDER IT APPROPRIATE TO RESTORE THIS ISSUE RELATING TO ADJ USTMENT ON ACCOUNT OF CAPACITY UTILIZATION IN THE CASE OF ASSESSEE COMPANY TO TH E FILE OF AO/TPO FOR DECIDING THE SAME AFRESH KEEPING IN VIEW THE SAID GUIDELINES. I F THE EXACT DETAILS OF CAPACITY UTILIZATION OF THE COMPARABLE COMPANIES ARE NOT A VAILABLE IN THE PUBLIC DOMAIN, THE AO/TPO IS DIRECTED TO OBTAIN THE SAME DIRECTLY FRO M THE CONCERNED PARTIES AND TO DECIDE THIS ISSUE AFRESH AFTER GIVING ASSESSEE AN O PPORTUNITY OF BEING HEARD. I.T.A.NO.8109/MUM/2011 CROSS-OBJECTION NO.228/MUM/2012 14 12. IN THE RESULT, APPEAL OF THE REVENUE IS DISMIS SED WHILE CROSS-OBJECTION OF THE ASSESSEE IS TREATED AS ALLOWED FOR STATISTICAL PURP OSES. ORDER PRONOUNCED IN THE OPEN COURT ON 7TH MAY, 2014 & - . 7TH MAY, 2014 & SD SD ( / VIVEK VARMA ) ( . . / P.M.JAGTAP) / JUDICIAL MEMBER / ACCOUNTANT MEMBER MUMBAI: ON THIS 7TH TH DAY OF MAY, 2014 . . ./ SRL , SR. PS ' #$&' (' / COPY OF THE ORDER FORWARDED TO : 1. ' / THE APPELLANT /APPLICANT 2. #$' / THE RESPONDENT. 3. 3 ( ) / THE CIT(A)- 4. 3 / CIT 5. #5 , ) 5 , / DR, ITAT, MUMBAI 6. / GUARD FILE. / BY ORDER, TRUE COPY (ASSTT. REGISTRAR) ) 5 , /ITAT, MUMBAI