ITAT Bangalore Upholds Capacity Utilisation and Working Capital Adjustments in Transfer Pricing: IKA India Pvt. Ltd. vs ACIT
Background and Overview
IKA India Pvt. Ltd., a company engaged in the manufacture and trading of laboratory and processing equipment, filed an appeal before the Income Tax Appellate Tribunal (ITAT), Bangalore, challenging the order passed by CIT(Appeals)-3, Bengaluru dated 12.09.2017 for Assessment Year 2013-14. The case centered primarily on transfer pricing adjustments relating to the assessee's international transactions with its Associated Enterprises (AEs) under the IKA Group.
The assessee's business operations involved importing products from the IKA Group for domestic sale, manufacturing and exporting finished goods to the IKA Group, and rendering research and development, marketing, and technical support services to group entities.
International Transactions Under Scrutiny
The assessee filed its return of income on 30th November 2013, declaring taxable income of Rs. 82,39,710. During the relevant previous year, the assessee entered into the following international transactions with its AEs:
| Nature of Transaction | Amount (Rs.) |
|---|---|
| Import of raw materials and components | 8,53,90,600 |
| Export of finished goods | 14,40,84,509 |
| Purchase of traded goods | 2,62,99,700 |
| Provision of marketing support services | 2,59,94,545 |
| Research and development fees | 6,29,16,160 |
| Payment of royalty | 2,06,19,173 |
| Payment of interest on loan | 16,65,636 |
| Payment of personnel support fees | 2,42,63,031 |
| Purchase of fixed assets | 18,84,045 |
| Reimbursement of expenses to AE | 68,71,417 |
The Transfer Pricing Officer (TPO), acting under Section 92 of the Income Tax Act, 1961, accepted all the above transactions as being at arm's length — except the export of finished goods to the AE, which became the central subject of dispute.
Transfer Pricing Methodology and TPO's Fresh Analysis
Assessee's Approach
The assessee adopted the Transactional Net Margin Method (TNMM) as the most appropriate method for benchmarking its manufacturing transaction. Using the Capitaline database, the assessee identified comparable companies and employed Operating Profit to Operating Cost (OP/OC) as the Profit Level Indicator (PLI). Financial data for FY 2012-13 was used for comparable companies. Crucially, the assessee also applied adjustments for:
- Capacity underutilisation during the relevant year
- Working capital differences between the assessee and comparable companies
After such adjustments, the assessee's net margin stood at 18.97% on operating cost and 15.95% on operating revenue, exceeding the arithmetic mean of 4.80% (OP/OC) derived from three comparable companies selected in the TP study. The assessee therefore claimed that the export transaction was at arm's length.
Three Comparables Selected by the Assessee
| S.No. | Company | OP/OR (%) | OP/OC (%) | TPO Decision |
|---|---|---|---|---|
| 1 | Allengers Medical Systems | 6.97% | 7.10% | Accepted |
| 2 | Gansons Limited | 2.99% | 3.00% | Rejected |
| 3 | Systronics India Ltd. (Seg.) | 4.36% | 4.38% | Rejected |
| Arithmetic Mean | 4.77% | 4.80% |
TPO's Revised Analysis
The TPO rejected two of the three companies selected by the assessee and conducted an independent fresh search, ultimately arriving at a set of 13 comparable companies with an unadjusted arithmetic mean of 8.61% on OP/OC. The TPO's final set of comparables was as follows:
| S.No. | Company | OP/OR (%) | OP/OC (%) |
|---|---|---|---|
| 1 | Hindustan Syringes & Medical Devices | 10.14 | 11.28 |
| 2 | Artificial Limbs Mfg. Corporation of India | 16.90 | 20.34 |
| 3 | Allengers Medical Systems Ltd. | 9.88 | 10.96 |
| 4 | Elico Limited | 12.99 | 14.93 |
| 5 | Premier Medical Corporation Pvt. Ltd. | 2.20 | 2.25 |
| 6 | Centenial Surgical Suture Ltd. | 6.72 | 7.20 |
| 7 | Blue Neem Medical Devices Pvt. Ltd. | 15.63 | 18.52 |
| 8 | Iscon Surgicals Ltd. | 8.83 | 9.68 |
| 9 | Johari Digital Healthcare Ltd. | 5.75 | 6.10 |
| 10 | Hemanth Surgical Industries Ltd. | 7.01 | 7.54 |
| 11 | Shree Pacetronix Ltd. | 8.73 | 9.57 |
| 12 | Continental Controls Ltd. | 8.24 | 8.98 |
| 13 | Care Medical Devices Ltd. | -1.14 | — |
| Arithmetic Mean | 8.61 | 9.7 |
Resulting Transfer Pricing Adjustment
The TPO computed the arm's length price adjustment under Section 92CA of the Income Tax Act, 1961 as follows:
Operating Cost: Rs. 39,20,72,536
**Arm's Length Mean Margin (OP/OC%)😗* 8.61%
**Arm's Length Price (108.61% of Operating Cost)😗* Rs. 42,58,29,981
Operating Revenue Reported: Rs. 40,08,75,618
Transfer Pricing Adjustment: Rs. 2,49,54,363
A notable asymmetry in the TPO's approach was that foreign exchange gains/losses were treated as non-operating for comparable companies but as operating for the assessee — and no adjustments were made for differences in working capital or capacity utilisation between the assessee and the comparables.