2013 (2) TMI 94 - AT - Income Tax

Tribunal rules for assessee on transfer pricing and warranty expenses.

The Tribunal ruled in favor of the assessee regarding both the transfer pricing adjustment and the provision for warranty expenses. The Tribunal agreed ... Transfer pricing adjustment - whether to determine ALP in respect of business activity relating to distribution segment of the assessee with the AE is to be considered by RPM or TNMM - Held that:- ALP in respect of international transactions whereby the assessee imports equipments from its AE and re-sells them without any value addition to the Indian customers the RPM would be the most appropriate method for determining the ALP as decided in in the case of L'Oreal India Pvt. Ltd. (2012 (11) TMI 175 - ITAT MUMBAI) referring to the OECD guidelines wherein a view has been expressed that RPM would be the best method when a re-sale takes place without any value addition to a product. In the present case, the assessee buys products from the AE and sells it without any value addition to the Indian customers in that event, the GP as a percentage of sales arrived at by the TPO insofar as trading activity of comparables identified by the TPO at 12.90%. The GP as a percentage of sales of the assessee is at 35.6% which is much above the percentage of comparables identified by the TPO. In such circumstances no adjustment could be made by way of ALP. Therefore, accept the alternative plea of the assessee and delete the addition made by the AO - in favour of assessee. Disallowing the provision for warranty expenses - Held that:- The assessee has given a detailed basis on which provision for warranty has been arrived at. As seen from the methodology that the assessee takes into account the warranty liability for the accounting period after bifurcating the likely cost on account of labour, material etc. & the summary of the provision also shows that wherever excess provision was made in an earlier year, the same is reversed in the subsequent period. The claim made by the assessee prima facie shows that the estimate is made by the assessee on scientific basis and reasonable basis. Since neither the AO nor the DRP have given any contrary findings with regard to the methodology adopted by the assessee in making provision the claim made by the assessee should be accepted. Assessee satisfies the criteria for claiming deduction on account of provision for warranty as laid down by in the case of Rotork Controls (P.) Ltd. (2009 (5) TMI 16 - SUPREME COURT OF INDIA) and Ericssion Communications (P.) Ltd (2009 (9) TMI 710 - DELHI HIGH COURT) - in favour of assessee. Issues Involved:1. Transfer Pricing Adjustment.2. Disallowance of Provision for Warranty Expenses.Detailed Analysis:1. Transfer Pricing Adjustment:The core issue pertains to the transfer pricing adjustment made by the Assessing Officer (AO) which was partly confirmed by the Dispute Resolution Panel (DRP). The assessee, engaged in the distribution of telecom equipment and accessories, conducted a transfer pricing study using the Transactional Net Margin Method (TNMM) for both its trading and commission agency activities. However, the Transfer Pricing Officer (TPO) segmented the financial results and applied separate Arm's Length Prices (ALP) for the trading and indent sales activities.The TPO's assessment showed a negative margin of -13.30% for the trading segment, compared to an arm's length margin of 3.34% for 31 comparable companies. For the indent sales segment, the appellant's margin was 62.84%, against an arm's length margin of 9.95% for 137 comparable companies. The TPO made an adjustment of Rs. 209,76,289 for the trading activity, which was later modified to Rs. 87,65,418 by the DRP, resulting in a net adjustment of Rs. 122,10,871.The assessee argued that the Resale Price Method (RPM) should be the most appropriate method for determining the ALP, as supported by the ITAT Mumbai Bench decision in ITO v. L'Oreal India Pvt. Ltd. The Tribunal agreed, noting that the RPM is suitable when goods are resold without any value addition. The Tribunal observed that the gross profit margin of the assessee was 35.61%, significantly higher than the 12.90% of the comparables identified by the TPO. Consequently, the Tribunal concluded that no adjustment was necessary, allowing ground Nos. 2 to 7 in favor of the assessee.2. Disallowance of Provision for Warranty Expenses:The second issue involves the disallowance of the provision for warranty expenses amounting to Rs. 19,09,604. The AO treated this provision as an unascertained liability. The assessee highlighted that the provision was computed on a scientific basis, considering various factors such as warranty periods, past warranty expenses, inflation adjustments, probability of claims, and sales growth. The methodology was consistent with accepted accounting principles and had been audited.The DRP, however, concluded that the provision was not made on a scientific basis, relying on the AO's remand report. The Tribunal examined the detailed methodology provided by the assessee and found it to be scientific and reasonable. The Tribunal referred to the Supreme Court's decision in Rotork Controls (India) (P.) Ltd. v. CIT, which held that a reliable estimate of liability arising from a past obligating event is a justified basis for claiming expenditure. The Tribunal also cited the Delhi High Court's decision in CIT v. Ericsson Communications (P.) Ltd., supporting the deduction of warranty provisions made on a scientific basis.Since neither the AO nor the DRP provided contrary findings on the methodology, the Tribunal directed that the assessee's claim for the provision of warranty expenses should be allowed, thus resolving ground No. 8 in favor of the assessee.Conclusion:The appeal by the assessee was partly allowed, with the Tribunal ruling in favor of the assessee on both the transfer pricing adjustment and the provision for warranty expenses.