If adjustment has not been made in final assessment order due to absence of requisite submissions, then adjustment has to be carried forward in computing assessee’s PLI as well as PLI of comparables.

1. The captioned appeal by assessee for Assessment Year [AY] 2008-09 contest the final assessment order passed by Ld. Assistant Commissioner of Income Tax-Circle 8(3), Mumbai [AO] u/s 143(3) (of Income Tax Act, 1961) read with Section 144C (of Income Tax Act, 1961) pursuant to the directions of Ld. Dispute Resolution Panel [DRP]. During hearing, the following effective grounds of appeal have been urged before us: -

I. Grounds of objections in respect of transfer pricing adjustment

4.Ground of Objection 4- Rejection of certain companies identified by the Appellant in the transfer pricing report Erred in rejecting certain comparable companies from the set of comparable identified by the Appellant in its transfer pricing report

5.Ground of Objection 5- Non consideration of correct operating margins of comparable companies adopted in the TP Order

Erred in considering incorrect operating margin of comparable companies adopted in the Order

6.Ground of Objection 6- Non exclusion of provision for inventory obsolescence from the operating cost of the Appellant.

Erred on facts and in circumstances of the case and in law by not excluding INR 61,825,865/- pertaining to provision for inventory obsolescence (being non-operating in nature) from the operating cost of the Appellant for AY 2008-09

7.Ground of Objection 7-Treating loss on sale of fixed assets as operating in nature for the purpose of computing operating margins of the Appellant Erred in treating INR 3,905,868 pertaining to loss on sale of fixed assets as operating in nature for the purpose of computing operating margins of VSIPL for AY 2008-09, and accordingly not considering correct operating margin of VSIPL

8.Ground of Objection 8-Non-consideration of risk adjustment Erred on the facts and circumstances of the case and in law by comparing full-fledged risk bearing entities with the Appellant, without making any adjustment on account of differences between the risk profile of comparable companies vis-à-vis the Appellant.

9.Ground of Objection 9- Transfer pricing adjustment without giving benefit of +/-5 per cent as available under erstwhile proviso to section 92C(2) (of Income Tax Act, 1961) Erred in computing the arm’s length price as the mean arm’s length price determined, without taking into account the lower 5 percent variation from the mean arm’s length price determined

II. Grounds of objections in respect of disallowances/additions other than transfer pricing adjustment

11. Ground of Objection 11- Non consideration of additional deduction on account of depreciation on projector and not granting of relief for disallowance of provisions in earlier year

Erred on the facts and circumstances of the case and in law by not granting additional deduction on account of depreciation on projector (as a result of approach followed in assessment proceedings for AY 2004-05) amounting to Rs.6,851 and not granting relief for disallowance of provisions disallowed in earlier year amounting to Rs.27,92,198.

2.1 Facts in brief are that assessee being resident corporate assessee engaged in manufacturing and trading of semiconductor devices including DIP bridge rectifiers was assessed u/s 143(3) (of Income Tax Act, 1961) at Rs.23.76 Crores after certain Transfer Pricing [TP] adjustment of Rs.16.13 Crores & Stock Obsolescence adjustment of Rs.2.58 Crores as against revised returned income of Rs.5.04 Crores e-filed by the assessee on 29/03/2010. The primary subject matter of this appeal is TP adjustment made in the computation of income.

2.2 During assessment proceedings, the International Transactions carried out by the assessee with its Associated Enterprises [AE] as reported in Form 3CEB were referred for determination of Arm’s Length Price [ALP] u/s 92CA(1) (of Income Tax Act, 1961) to Ld. Transfer Pricing Officer [TPO] on 12/05/2010. The issue under appeal is related with determination of ALP of goods exported by the assessee amounting to Rs.86.73 crores (net of sales return) to its AE situated in Italy. Majority of the sale turnover achieved by the assessee in the impugned AY was by way of export to its AE situated in Italy.

2.3 The assessee adopted Transactional Net Margin Method [TNMM] method to benchmark these transactions with operating Profit / Total Cost [OP/TC] as the Profit Level Indicator [PLI], the assessee being the tested party. The assessee’s PLI came to 6.90% as against mean PLI of 9.49% of 15 comparables as selected by the assessee in its TP study and therefore, the same being within the tolerance range of +/-5%, the transactions were claimed to be at Arm’s length Price [ALP]. The prime dispute under appeal is related with computation of correct PLI reflected by the assessee and selection / rejection of certain comparables.

2.4 As noted by Ld. TPO, the assessee was engaged in the business of labor assisted assembly process of semi-conductor devices of different types which were mainly used in general power management applications. Semi-conductor manufacturing involved two phases of production-Wafer Fabrication and Assembly. The assessee was primarily an assembler of semi-conductor devices such as rectifiers, discrete and modules which were essentially low technology activity involving manual labor operations. The specialized nature of business activity carried out by the assessee shall have bearing on selection / rejection of certain comparables as discussed by us in succeeding paragraphs. The nature of business, as per assessee’s submissions, which is extracted by Ld. TPO in his order, is as follows:- Semiconductor manufacturing involves two phases of production wafer fabrication and assembly process. Wafer fabrications requires a sequence of process steps that expose silicon wafers to chemicals that change their electrical properties. The chemicals are applied in patterns that define cell or circuits within numerous individual devices termed ‘die’ or ‘chips’ on each wafer. VSIL is engaged in the assembly process of manufacturing of semiconductor devices. The process followed by VSIL in arriving at its end produce (i.e. semiconductor devices of different types) is described as below:-

• VSIL procures raw material of different types to be used in the manufacturing process of semiconductor devices.

• Depending upon the nature of semiconductor devices to be manufactured, various types of raw material procured are manually assembled (i.e. process of manual assembly or dice pre-soldiering)

• The pre-soldiering dice undergoes through a furnace brazing process. Brazing is a metal joining process whereby a filter metal is heated above and distributed between two or more close fitting parts by capillary action. Furnace blazing is a semi automatic process whereby the metal joining process takes place in furnace.

• The devices are manually assembled and each manually assembled device undergoes a furnace brazing process.

• Depending upon the semiconductor device to be manufactured instead of the process of furnace brazing, the process of compression or wire bonding is also performed (compression is a metal joining process whereby metals are bonded using high pressure / force and wire bonding is the process of making interconnections using metals like aluminum or copper.

• The resultant product then undergoes testing for quality processes, labeling and packing before being sold to the customer. Post processing of raw material as per the above processes, a new and different produce (in the form of rectifiers i.e. discrete, modules or bridges) is obtained which cannot be dismantled or brought back to the raw material stage. Further the same has a distinctive character and use.

Based on the above it can be noted that VSIL is not engaged in the assembly activity wherein certain parts are brought together and attached to each other using screws, connectors etc. VSIL is engaged in manufacturing process of semiconductor devices of different types and it is the general industry practice to call such process as ‘assembly process’. Considering the same we submit that the companies identified in the transfer pricing study report are functionally comparable to VSIL.

2.5 So far as the computation of assessee’s PLI is concerned, the only issue involved is adjustment of provision for inventory obsolescence of Rs.6.18 Crores & Loss on Sale of Fixed Assets for Rs.0.39 Crores.

These two items, as per assessee’s submissions, were not part of operating income and hence not required to be adjusted / deducted while computing assessee’s operating margins whereas the Ld. TPO opined that the same being operating in nature, require adjustment while computing operating income reflected by the assessee. The adjustment of these two items brought down assessee’s PLI to -1.05%, which was adopted by Ld. TPO to compute the impugned Transfer Pricing Adjustment [TP].

2.6 The second issue is related with selection / rejection of comparables. After considering functional comparability, the Ld. TPO, in the final analysis has adopted the five comparables and rejected the other by observing as under:-

6.6 The assessee’s above submissions are considered. It is seen that the company K.Dhandhapani & Co. cannot be considered as comparable as it is involved in manufacture of various items which are not semi-conductors. Many of the other companies identified by the assessee are into manufacturing or printed circuit board and capacitors. It is seen that these are full fledged manufacturing activities and hence cannot be considered as functionally comparable to the assessee. The companies which are involved in production of rectifiers, diodes, thyristors are considered functionally comparable, as the functional activities are same and products manufactured are similar. As a result, the following companies are considered as functionally comparable to the assessee

The stand of Ld. TPO has led to the exclusions of following comparables as selected by the assessee in its Transfer Pricing [TP] study:-

The rejection of one comparable, namely Salora International Ltd. is not under dispute before us.

2.7 Finally, the differential of mean PLI i.e. 17.20% and the assessee’s revised PLI i.e. -1.05% has led to impugned TP adjustment of Rs.16.13 Crores. The same was incorporated in the draft assessment order dated 24/12/2011 in terms of Section 92CA(4) (of Income Tax Act, 1961) which was subjected to assessee’s objections before Ld. DRP.

3. Aggrieved, the assessee raised objections against the same with little success before Ld. DRP vide directions u/s 144C(5) (of Income Tax Act, 1961) dated 24/09/2012. The submissions made by the assessee against the draft

Sr. No. Name of Company OP/TC

1. HBL Power Systems 12.08

2. Hind Rectifiers 25.23

3. Karnataka Hybrid Micro Circuits Ltd 22.94

4. Naina Semi Conductors 13.67

5. Rutton Shah Intl. Rectifiers Ltd 12.07 Average 17.20

Sr. No. Name of Company OP/TC

1. BCC Fuba Ltd. 0.29

2. Circuits Systems Ltd. 15,73

3. Fine-Line Circuits Ltd -2.54

4. Incap Limited 8.96

5. K.Dhandhapani & Co. Ltd. 3.86

6. Precision Electronics Ltd 1.99

7. SPEL Semiconductor Ltd 20.50

8. Solectron EMS Ltd 6.56

9. Sulakshana Circuits Ltd 4.29 assessment order could not find favor before Ld. DRP and the stand of lower authorities on most of the issues has been confirmed by Ld. DRP. Accordingly, incorporating the aforesaid directions u/s 144C(5) (of Income Tax Act, 1961) of Ld. DRP, final assessment order dated 30/10/2012 has been passed, which has further been contested before us by the assessee by way of present appeal.

4. The Ld. Authorized Representative [AR], by way of written submissions and with the help of tabular chart, has assailed the additions made by lower authorities and placed reliance on several judicial pronouncements to support the various submissions. The same has been controverted by Ld. Departmental Representative [DR]. Vehement arguments have been adduced by both the representatives qua computation of assessee’s PLI and selection / rejection of comparables.

5.1 We have carefully perused the rival contentions and perused relevant material on record. Upon due consideration, we find that whole controversy primarily revolves around computation of assessee’s PLI and selection / rejection of nine comparables besides some minor issues.

5.2 First, we deal with computation of assessee’s PLI. So far as the adjustment of loss on sale of fixed assets is concerned, we find that Ld. DRP has concurred with the stand of the assessee that the same do not form part of operating cost. At the same time, the Ld. AO was directed to verify the claim of the assessee and was further directed to exclude the said item while arriving at PLI of the comparables. However, in the absence of requisite submissions / computations made by assessee, the said adjustment has not been made in the final assessment order.

Therefore, at the outset, we direct Ld. AO to carry out the said adjustment in computing the assessee’s PLI as well as PLI of the comparables with a direction to the assessee to provide the requisite details in this regard. Ground Number 7 of the appeal stand allowed for statistical purposes.

5.3 The second adjustment pertains to provision for stock obsolescence adjustment while computing assessee’s operating margin. The assessee, in its TP study, treated the provision for inventory obsolescence of Rs.6.18 Crores as non-operating in nature and accordingly computed the assessee’s PLI as 6.90%. The assessee submitted that it had revised the estimates for determining the provision for inventory obsolescence in accordance with Group Policy and management estimates and accordingly, the said amount has been charged to the Profit & Loss Account. The same being non-recurring item due to change in inventory valuation policy, was non-operating in nature. However, not convinced, Ld. TPO treated the same as operating expenditure and revised assessee’s PLI to -1.05% by making following observations:-

6.4 The assessee’s plea is not acceptable. It was not demonstrated that this provision is included in the operating cost enumerated above. There is no mention of this in the annual report. Hence the OP/TC is worked out to be as follows:-

Op. Revenue 87,49,42,147

Op. Cost 88,42,05,285

Loss 92,63,138

OP/TC -1.05%

The Ld. DRP has confirmed the stand of Ld. TPO by making following observations:-

33. We have considered the submissions of the assessee, the views of the Assessing Officer and the material on record. This is against the TPO not accepting the provision for inventory absolutions from the operating cost.

The TPO has mentioned in the order that the assessee's claim is not acceptable as it was not demonstrated whether this provision is included in the operating cost. The assessee has submitted the copies of the Director's report and Notes to Account to the Balance Sheet of the assessee company. It is mentioned in the Directors report that during the year there was a revision in the estimates for determining the provision for obsolescence of inventory. It is mentioned in the notes to account at para 14 that the provision for inventory obsolescence had been revised during the year. The total amount charged to P & L account for the current year was Rs. 61,825/-. The assessee has explained in the submission that the amount is in thousands, which means the actual amount was Rs.6,18,25,000/-. In the profit and loss account, the obsolescence is not separately shown under the operating expenses at Schedule No.14. The note at item 14 of the notes to account also does not specify under which head of expenditure this amount is debited in the profit and loss account. The Assessing Officer is, therefore, correct in observing that the assessee has not demonstrated that the provision is included in the operating cost computed by the assessee.

34. It is also not explained whether such provision has been made for the first time and as an extraordinary measure. This does not appear to be so from the note No. 14 which states that the company has revised the estimates, in this year. It appears that in the industry obsolescence is quick and therefore, provisions have to be made. If this is a regular feature, then such expenditure for provision should also be debited in the accounts of the comparable companies which manufacture similar products. The assessee has not proved that such expenditure is unique to its own case and that such provision does not occur in the comparable cases, in such event only, a suitable adjustment or even exclusion could be necessary. Without the relevant details, it would not be proper to exclude such provision from the operating cost, as claimed by the assessee.

5.4 The Ld. AR, drawing our attention to the financial statements, Directors’ Report and other documents placed in the paper-book, has reiterated the contentions. It has been submitted that the impugned provision was non-recurring in nature as there was change in stock valuation policy during the impugned AY and the same one time extra- ordinary event and therefore the provisions were non-operating in nature. Per Contra, Ld. DR submitted that stock valuation was part and parcel of the assessee’s operations and the assessee in subsequent years has treated similar provisions as operating in nature and therefore, the action of lower authorities was justified.

5.5 So far as the observations of the lower authorities are concerned, upon perusal of financial statements, we find that aforesaid provision has not been directly debited by the assessee in the Profit & Loss Account under any of the following heads:-

Purchase of Traded Goods

Personnel Cost

Operating & Other Expenses

Financial Expenses Depreciation

The only head under which this adjustment could be made by the assessee was ‘Material Consumed’, the details of which are available at Schedule No. 12. Prima facie, it appears that the adjustment of this item has been made while arriving at Stock valuation of raw material / finished goods/work-in-progress at year end. The item-wise details of the same has been placed on page numbers 1025 to 1059, the perusal of which reveal that the assessee has identified each and every item of the stock and arrived at figures thereof and written off the same while valuing the closing stock. At the same time, the assessee, in computation of income, has added back this item treating the same as provisions and claimed an amount of Rs.2.58 Crores against the same on account of stock actually destroyed by the assessee out of these items before filing of return of income. The pleadings made by the assessee reveal that the deduction of Rs.2.58 Crores has been allowed to the assessee in subsequent years. These factors, in our opinion, are not at tandem with each other and require re-appreciation. The lower authorities had also rejected the assessee’s stand primarily by noticing that the said item was not debited in the Profit & Loss Account. This issue remains unaddressed before us also and the factual matrix is not clear. Therefore, the issue is remitted back to the file of Ld. AO / TPO for appreciation of the factual matrix and re-adjudicate the same with a direction to the assessee to demonstrate / substantiate his stand in this regard. In principle, we are of the opinion that stock valuation is done in accordance with policy adopted by the management in this regard and the same constitute part and parcel of assessee’s trading operations only particularly when assessee was technology driven company and exposed to this kind of risk in normal course of business. Resultantly, Ground No. 6 stands allowed for statistical purposes.

6. Ground No. 5 is related with adoption of correct margins of comparables adopted by Ld. TPO. In this regard, Ld. AR seeks endorsement of Ld. DRP directions only. As evident from the order of Ld. TPO, the assessee vide its letter dated 29/04/2011 pointed out errors in margins of the comparables adopted by the Ld. TPO which were not considered while arriving at the adjustment. The Ld. DRP, vide para-30 directed Ld. TPO to consider the submissions of the assessee and make necessary rectifications. Needless to add that errors, if any, which have crept into while computing margins of the comparables are to be rectified and therefore, Ld. TPO is directed to consider the submissions of the assessee forthwith in this regard. Ground No. 5 stand allowed for statistical purposes.

7.1 In Ground No. 4, the assessee is aggrieved by rejection of nine comparables selected by him in his TP study. The prime argument of Ld. AR, in this regard, is that these comparables have been accepted by the revenue in subsequent years and therefore, the same were to be accepted in impugned AY also in view of rule of consistency. We do not agree with the same since there could not be any rule of consistency in the matter of comparables since TP study for a particular year is unique for each year and depend upon the functions performed, risk assumed and assets employed by the entities and the same could not applied blindly to any other years unless it is demonstrated that the entities were exposed to similar business environment / risk and in fact, comparable in those years. At the same time, we find that the methodology adopted to benchmark the transactions is TNMM method which require only a broad functional comparability of the entities and do not envisage product to product comparison, provided the comparables were operating in similar business environment and exposed to identical business situation. In the above backdrop, we proceed with the matter of comparables, as urged before us.

7.2 A perusal of assessee’s TP study reveal it was engaged in labor assisted assembly process of semiconductor devices of different types which were mainly used in general power management applications. The various products being manufactured by the assessee were Rectifiers / diodes / Bridges / Modules and Discrete which were essentially a low technology activity involving manual labor operations. These products find use in various electronic and industrial applications including motor and lighting controls, welding equipments, forklifts, machine tools, induction heating, locomotives, motor drive production lines, smelting equipment and power supplies. In contrast to this, the nine comparables, as evident from page numbers 83 to 85 of the paper book, were primarily engaged in following line of business:-

The Ld. TPO has rejected the same on the ground that these were functionally dissimilar. On the other hand, as per assessee’s submissions, semi-conductor devices, capacitors and PCBs are all are all being used for general power management applications and therefore comparable. Upon due consideration, we find that the important factor to adjudge the comparability is nature of manufacturing process being carried out by the assessee as well as the comparables since we have already noted that TNMM method require only broad product comparability and not product to product comparison. It is also noted that Ld. TPO, in AY 2009-10, has accepted few of these comparables, finding them functionally comparable to the assessee. Therefore, the matter stand remitted back to the file of Ld. AO / TPO to re-appreciate the functional comparability between assessee and the nine comparables with a direction to the assessee to demonstrate the same with requisite material. This ground stands allowed for statistical purposes.

8.1 By way of Ground Number 8, the assessee seeks risk adjustment while arriving at ALP of the international transactions. The assessee, Sr. No. Name of Company Product

1. BCC Fuba Ltd. Printed Circuit Boards

2. Circuits Systems Ltd. Printed Circuit Boards

3. Fine-Line Circuits Ltd Printed Circuit Boards

4. Incap Limited Capacitors

5. K.Dhandhapani & Co. Ltd. Capacitors

6. Precision Electronics Ltd Printed Circuit Boards

7. SPEL Semiconductor Ltd Integrated Circuits

8. Solectron EMS Ltd Printed Circuit Boards

9. Sulakshana Circuits Ltd Printed Circuit Boards before lower authorities, had contended that it was not into significant Research & Development and therefore, not exposed to associated risks and entire production was sold to its AE. Therefore, it was to bear limited business risk, market risk, product liability risk, credit & collection risk etc. as against comparable companies which were full risk bearing independent entries. Hence, it was entitled for risk adjustment in terms of various judicial pronouncements. The Ld. DR has assailed the same on the ground that there was nothing on record to suggest that the comparables were full risk bearing entities and further, the assessee was completely dependent on its AE to achieve the turnover and hence, exposed to more risk in the sense that any adverse impact on AE shall have direct and corresponding adverse impact on the assessee. It was further submitted that the assessee was exposed to several other risks viz. technology risk and foreign exchange risk etc.

8.2 Upon due consideration, we strength in the arguments advanced by revenue that keeping in view the nature of assessee’s business, it was exposed to varied risks viz. technology risk & foreign exchange risk etc. and further, there is nothing on record to suggest that all the comparables were full risk bearing entities. This is evident and fully supported by our observation at para-5.5 where it is noted that the assessee has written-off an amount of Rs.6.18 crores for stock obsolescence which has actually been destroyed over a period of time and deduction thereof has been claimed by the assessee. Therefore, we have no hesitation in concluding that the assessee was certainly exposed to technology risk. Secondly, it is noted that Ld. DRP has rejected the ground of the assessee by making following observations:-

42. We have considered the submissions of the assessee, the views of the Assessing Officer and the material on record. A necessary condition before such adjustment is made is there should be complete financial details with regard to the comparable companies, the process employed in the business, the turnover rate etc. Without a full knowledge of the comparable companies, such adjustment cannot be made. A calculation based on a mathematical model does not necessarily give a proper result. This ground is rejected.

We concur with the stand of Ld. DRP also in this regard since the adjustment could not be provided to the assessee on mere assumptions without there being any cogent material on record to substantiate those assumptions / contentions. Resultantly, this ground stand dismissed.

9. Ground Number 9 is related with benefit of +/-5% in terms of erstwhile proviso to Section 92C(2) (of Income Tax Act, 1961) which has been rejected by Ld. DRP in terms of Board’s Circular No. 142/13/2010-SO (TPL) dated 30/09/2010. Prima facie, the said circular applies to pending proceedings as on 01/10/2009. Therefore, since the matter of comparable has already been remitted back to the file of Ld. AO / TPO, at the moment, we can only direct the lower authorities to grant adjustments / concessions, which are available to the assessee within the framework of law while determining ALP of the transactions as aforesaid. This ground stand allowed for statistical purposes.

10. By way of Ground No. 11, the assessee is seeking endorsement of Ld. DRP’s directions which are related with depreciation on projectors and allowance of provisions disallowed in earlier years. We find that directions to verify the same has already been provided by Ld. DRP vide Para No. 54 of its directions. By endorsing the same, we direct the Ld. AO to verify the claim of the assessee in the light of submissions made before Ld. DRP. This ground stands allowed for statistical purposes.

11. All the grounds stand disposed-off in the following manner:-

12. The appeal stands partly allowed for statistical purposes in terms of our above order.

Order pronounced in the open court on 04th May, 2018.

Sd/- Sd/-

(Mahavir Singh) (Manoj Kumar Aggarwal)

Judicial Member / Accountant Member

Mumbai;Dated : 04.05.2018