Capacity Utilization Adjustment in transfer pricing allowed for early years of operation where comparables had on average higher utilization
ABCAUS Case Law Citation:
ABCAUS 3062 (2019) (07) ITAT
Important Case Laws Cited/relied upon by the parties:
Global Vantedge (P) Ltd. Vs. DCIT
E-Gain Communications Pvt. Ltd. 118 TTJ 354
In The instant case, the issue involved was the order of the CIT(A) allowing Capacity Utilization Adjustment for Comparables.
The had CIT(A) observed that the transfer pricing regulation namely Rule 10(B)(2) and Rule 10(B)(3) prescribe that in order to make comparability meaningful and the conditions prevailing in the market in which the tested party and comparables operates have to be considered while judging comparability of an international transaction with an uncontrolled transaction and suitable adjustments have to be made to eliminate the material effects of such differences.
The CIT had placing reliance on the judgment of the High Court and the ITAT to arrive at that adjustments had to be carried out for the purpose of comparability analysis.
Before the Tribunal the assessee submitted that the Commissioner of Income Tax(Appeals) had allowed “Capacity Utilization Adjustment”. However, the assessee prayed for suitable directions from the Bench that this “Capacity Utilization Adjustment” should be done in accordance with the directions given by the Co-ordinate Bench of the Tribunal in assessee’s own case.
The assessee submitted that its capacity utilization during the relevant financial year was only 49.53% as compared to the average 69.41% capacity utilization of its comparables. It was further submitted that due to the under-utilization of the capacity, the fixed cost of the assessee had been absorbed by less number of units, thus lowering the net profit.
The assessee thereafter, proposed an adjustment to be made to the operating profit for the amount of under absorption of fixed costs. The assessee submitted that underutilization of capacity directly impacts profitability of the assessee in open market conditions.
The Tribunal observed that in assessee’s own case for the preceding year on the same issue, the Revenue had contested this ground against the order of the Commissioner of Income Tax (Appeals) directing the Assessing Officer/TPO to allow “Capacity Utilization Adjustment” by holding that the assessee was in early years of operation and has had only utilized 33% of the total capacity whereas the comparables had on an average utilized 50 to 70% of the total capacity requiring their margins to be adjusted accordingly.
Accordingly, following the decision of the Co-ordinate Bench of the Tribunal the Tribunal set aside the issue to the file of the Assessing Officer/ Transfer Pricing Officer with direction to apply procedure led out and worki out the adjustment on account of capacity utilization.