Capacity underutilization is certainly an important factor affecting net profit margin of enterprise as it results in higher costs per unit, which, in turn, result in lower profits. Thus, adjustment of capacity utilization is to be made to determine ALP of international transaction.
The Tribunal held as under:
1) Rule 10 B (1)(e)(ii) does indeed provide that the net profit margin realized in a comparable uncontrolled transaction is adjusted, inter alia, for differences in enterprise entering into such transactions, which could materially affect the net profit margin in open market;
2) Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Thus, the adjustment for capacity utilization was rightly approved by the CIT(A). - Panasonic AVC Networks India Co. Ltd. v. Dy. CIT  42 taxmann.com 420 (Delhi - Trib.)http://www.taxmann.com/income-tax-rules.aspx