2017 (9) TMI 1648 - AT - Income Tax

Tribunal grants appellant relief on key tax issues, including ALP adjustment and IPR depreciation.

The tribunal ruled in favor of the appellant on various issues, including the adjustment to Arm's Length Price (ALP) for international transactions, ... Transaction-by-transaction comparability - segmented profitability as basis for transfer pricing - entity wide / bundled evaluation of closely linked transactions - most appropriate method (MAM) and Profit Level Indicator (PLI) - Comparable Uncontrolled Price (CUP) method for royalty - management services - stewardship versus commercial intra group services - intangible property - knowhow as depreciable asset - depreciation on goodwill - ascertained liability - provisions and warranty - treatment of provisions in computation of book profits under section 115JB - MSMED interest - statutory crystallisation of liabilityTransaction-by-transaction comparability - segmented profitability as basis for transfer pricing - most appropriate method (MAM) and Profit Level Indicator (PLI) - Whether the transfer pricing adjustments should be determined by entity wide (combined) TNMM or by transaction/segment level benchmarking using certified segmental profitability - HELD THAT: - Tribunal examined the assessee's certified segmental statement segregating Manufacturing Domestic, Manufacturing Export and Trading segments and the TPO's adoption of an entity wide Meter Segment (including large third party domestic business). Relying on Rule 10B comparability factors and international guidance, the Tribunal held that where international transactions can be specifically related to particular business segments and segmental results are available, segmented (transaction by transaction) benchmarking provides a better approximation of arm's length conditions than aggregation with predominantly domestic third party business. The bundled/entity approach is permissible only as an exception when transaction level analysis is impracticable; that exception was not attracted here because the assessee produced segmental profit data and comparable analysis. The Tribunal directed the TPO/AO to use the certified segmental profitability for determining ALP of the impugned international transactions.Held for the assessee: use of segmented/transaction by transaction benchmarking accepted; combined entity wide TNMM rejected in the facts.Most appropriate method (MAM) and Profit Level Indicator (PLI) - sale of finished goods - Manufacturing Export segment - Whether the export sale of finished goods (Manufacturing Export segment) was at arm's length - HELD THAT: - Assessee selected itself as tested party and applied TNMM with OP/Sales as PLI, comparing its segmental OP/Sales to comparable manufacturers with significant export sales. The TPO had instead used the entire meter segment margin; Tribunal found the assessee's segmental comparables reliable (including audited financial data) and noted prior tribunal decisions in assessee's favour. On comparison, the assessee's segmental margin exceeded the comparable average and no adjustment was warranted.Export sales under Manufacturing Export segment held to be at arm's length; adjustment deleted.Cost Plus Method (CPM) - tested party selection - Associated Enterprise as tested party - purchase of materials - Manufacturing Domestic segment - Whether purchase of raw materials/components from AEs (Manufacturing Domestic segment) was at arm's length - HELD THAT: - The assessee benchmarked the margins retained by the AEs (selected as tested party) using GP/DICOP under CPM against comparable suppliers in the AEs' regions. The TPO rejected this and treated the assessee as tested party using entity level TNMM. The Tribunal, following earlier tribunal findings in assessee's own earlier years, found no material basis to reject the AE tested party CPM analysis and accepted that benchmarking AEs' margins with regional comparables appropriately established ALP.Purchase of materials/components held at arm's length; TPO's adjustment rejected.Resale Price Method (RPM) - trading segment - tested party and PLI selection - Whether purchases of finished goods in the Trading segment were at arm's length - HELD THAT: - Assessee applied RPM using trading segment gross profitability and identified Indian comparables; TPO combined trading with manufacturing and applied TNMM producing a lower comparable margin. Tribunal found that properly computed comparable margins (from audited statements) show the assessee's trading segment margin exceeded industry averages and that prior years' practice supported segmental benchmarking; accordingly no adjustment was warranted.Purchase of finished goods in Trading segment held to be at arm's length; no adjustment.Management services - stewardship versus commercial intra group services - transfer pricing officer's jurisdiction to value at NIL - Whether the intra group management service fees were stewardship (no charge) or commercial services requiring arm's length remuneration - HELD THAT: - TPO had classified the services as stewardship and imputed ALP at nil without applying a transfer pricing method and had ignored voluminous documentary evidence (sample emails, correspondence) of services received. DRP reviewed the documents, concluded primary beneficiary was the assessee and that services conferred commercial benefit that a third party would pay for. Tribunal held the TPO could not treat the fee as nil without applying TP methods and accepted the DRP's conclusion that the services were commercial and that the benchmarking and cost allocation submitted by assessee were acceptable.Services not stewardship; payment for management services held to be at arm's length and TPO's NIL valuation deleted.Comparable Uncontrolled Price (CUP) method for royalty - section 92C(3) - prerequisites for re determination - Whether royalty paid for technology/technical assistance was at arm's length - HELD THAT: - Assessee applied CUP using comparable royalty agreements and an appropriate database; TPO rejected the CUP analysis and imputed ALP at nil without specifying which limb of section 92C(3) justified departure from assessee's method. Tribunal observed that TPO must identify which condition in section 92C(3) is triggered before discarding taxpayer's MAM; prior tribunal orders in assessee's favour accepted CUP for royalty. DRP had deleted the TPO adjustment after considering the documentation. Tribunal held cup analysis acceptable and deleted the upward adjustment.Royalty payment accepted as at arm's length; TPO's NIL determination deleted.Intangible property - knowhow as depreciable asset - depreciation on intellectual property - Whether the amount paid for acquisition of business/TECRES (comprised of knowhow and other IPRs) qualified as intangible assets eligible for depreciation - HELD THAT: - TPO had denied depreciation alleging absence of government certification/registration. Tribunal relied on statutory definition of knowhow and OECD/BEPS guidance that knowhow and trade secrets need not be registered to be intangibles; assessee produced business transfer agreement, independent valuation attributing major consideration to IP, and transfer of R&D team. Earlier tribunal decisions in assessee's favour were followed. Tribunal held knowhow/other acquired IP qualified as intangible assets and directed allowance of depreciation and reworking of opening WDV.Depreciation on acquired intellectual property (knowhow/IP) allowed.Depreciation on goodwill - Whether depreciation on goodwill arising from the acquisition is allowable - HELD THAT: - Issue was earlier decided in assessee's favour for prior years and Tribunal followed that decision; assessee had paid consideration attributable to goodwill and prior appellate determinations supported allowance of depreciation. Tribunal allowed depreciation on the written down value of goodwill for the year.Depreciation on goodwill allowed.TDS credit - duty of AO to verify supporting certificates - Whether the assessee is entitled to the additional TDS credit claimed and whether AO must grant credit on verification - HELD THAT: - Assessee produced TDS certificates which the DRP directed the AO to verify and allow credit. AO in final order granted only part of claimed credit without reasons. Tribunal held that once supporting TDS certificates are produced the AO must verify whether the related income has been offered to tax and grant credit accordingly, and directed AO to grant the remaining credit after verification.Directed AO to verify and allow the remaining TDS credit claimed by the assessee.Ascertained liability - provisions and warranty - treatment of provisions in computation of book profits under section 115JB - Whether the provision for warranty is deductible under normal provisions and whether it must be added back in computing book profits under section 115JB - HELD THAT: - Assessee made a provision for replacement of specified defective meters identified by the purchaser and also maintained a conservative provision based on historical warranty experience; documentary evidence (correspondence, inspection, quantification) showed an obligating event and reliable estimate. Tribunal applied Supreme Court authority (Rotork and Bharat Earth Movers) and held the warranty provision (including the identified liability and the conservative accrual based on historic data) to be an ascertained liability and therefore deductible under normal provisions. Because the liability is ascertained (not an ad hoc provision for unascertained liabilities or diminution in asset value), it should not be added back while computing book profits under section 115JB.Warranty provision allowed as deduction; not to be added back in computation of book profits under section 115JB.Provision for obsolescence of inventory - valuation of inventory - AS 2 / lower of cost or net realizable value - treatment under section 115JB (provision for diminution in value) - Whether provision for obsolete inventories is deductible under normal provisions and whether it must be added back for book profit computation under section 115JB - HELD THAT: - Assessee identified slow moving/obsolete items from system records, applied graduated percentage provisions by ageing and valued inventory in accordance with AS 2 (lower of cost or NRV). Tribunal found the method commercially acceptable and supported by precedent (Hotline Teletube), held the provision deductible under normal provisions. However, because the Finance (No.2) Act 2009 (with retrospective effect) treats provisions for diminution in value of any asset as requiring add back under section 115JB, and the assessee conceded on the book profit point, the Tribunal held that the provision must be added back while computing book profits.Provision for obsolescence allowed as deduction under normal law; but to be added back for computation of book profits under section 115JB.MSMED interest - statutory crystallisation of liability - treatment in computation of book profits under section 115JB - Whether provision for interest payable under the MSMED Act is an ascertained liability and whether it must be added back while computing book profits under section 115JB - HELD THAT: - Assessee made provision for interest payable to MSME suppliers as per statutory formula under MSMED Act; a portion was already paid in the year. Tribunal noted MSMED section 23 disallows deduction 'notwithstanding' provisions in Income tax Act for normal income computation, but section 115JB's definition of book profits is autonomous and adds back only amounts set aside for provisions for 'other than ascertained liabilities'. Because MSMED interest is calculable by statutory formula and crystallised (partly paid) it constitutes an ascertained liability. Tribunal held that section 23 MSMED does not operate to enlarge the list of add back items under section 115JB and therefore the provision need not be added back in computing book profits.MSMED interest provision held to be an ascertained liability and not required to be added back while computing book profits under section 115JB.Final Conclusion: For AYs 2010 11 and 2011 12 the Tribunal allowed the assessee's segmented/transaction level transfer pricing approach and deleted TPO adjustments to export sales, purchases of materials and trading purchases; upheld the DRP in holding management fees and royalty at arm's length; allowed depreciation on acquired knowhow and goodwill; directed the AO to verify and grant remaining TDS credit; allowed warranty and obsolescence provisions under normal law (obsolescence to be added back for book profit computation as conceded), and held MSMED interest to be an ascertained liability not to be added back under section 115JB. Appeals by revenue dismissed; assessee appeals partly allowed as directed above. Issues Involved:1. Adjustment to Arm's Length Price (ALP) for international transactions.2. Disallowance of depreciation on Intellectual Property Rights (IPR).3. Disallowance of depreciation on Goodwill.4. Short credit of TDS.5. Provision for warranty.6. Provision for obsolescence of inventory.7. Provision for interest on MSMED.Detailed Analysis:1. Adjustment to Arm's Length Price (ALP) for international transactions:The appellant, engaged in manufacturing and distribution of electric meters, entered into various international transactions. The transactions were segmented into manufacturing (domestic and export), trading, and services. The Transfer Pricing Officer (TPO) rejected the transactional level analysis and adopted an entity-wide analysis, leading to adjustments in the ALP. The appellant argued for a transaction-by-transaction approach, citing Indian Transfer Pricing Regulations, OECD Guidelines, and UN TP Manual. The tribunal accepted the appellant's method, emphasizing that the segmentation provided a better and more scientific method for determining ALP. The tribunal directed the TPO to consider the certified segmental profitability for determining the ALP of the relevant international transactions.2. Disallowance of depreciation on Intellectual Property Rights (IPR):The appellant acquired intellectual property rights (IPR) from a sole proprietorship, including designs, software, and technical know-how. The Assessing Officer (AO) disallowed the depreciation claim, arguing that the IPR did not have government recognition. The tribunal, referencing earlier decisions and OECD guidelines, held that IPR, including know-how, does not require registration for depreciation claims. The tribunal allowed the depreciation on IPR, directing the AO to rework the opening WDV and subsequent depreciation.3. Disallowance of depreciation on Goodwill:The appellant claimed depreciation on goodwill arising from the acquisition of a business. The tribunal, referencing its earlier decisions and the Supreme Court's ruling in CIT v. Smifs Securities Ltd., allowed the depreciation on goodwill.4. Short credit of TDS:The appellant claimed TDS credit, which was partially disallowed by the AO. The tribunal directed the AO to verify the TDS certificates and allow due credit after ensuring the related income was offered to tax.5. Provision for warranty:The appellant made a provision for warranty based on scientific data and historical trends. The AO disallowed the provision, treating it as an unascertained liability. The tribunal, referencing the Supreme Court's decisions in Bharat Earth Movers and Rotork Controls India (P.) Ltd., held that the provision for warranty was an ascertained liability and allowed it under normal provisions and while computing book profits under Section 115JB.6. Provision for obsolescence of inventory:The appellant created a provision for obsolete inventory based on AS-2 guidelines. The AO disallowed the provision, treating it as an unascertained liability. The tribunal, referencing the Delhi High Court's decision in Hotline Teletube & Components Ltd., held that the provision for obsolete inventory was allowable as a business loss under normal provisions but should be added back while computing book profits under Section 115JB due to the retrospective amendment by the Finance (No. 2) Act, 2009.7. Provision for interest on MSMED:The appellant made a provision for interest on delayed payments to suppliers under the MSMED Act, 2006, and disallowed it under normal provisions but claimed it under Section 115JB. The tribunal held that the provision for interest was an ascertained liability and should not be added back while computing book profits under Section 115JB, emphasizing that Section 23 of the MSMED Act refers to computation under sections 29 and 57 of the Income Tax Act, not Section 115JB.Conclusion:The tribunal provided a detailed analysis of each issue, emphasizing the need for a scientific and systematic approach in determining ALP, recognizing the validity of depreciation claims on IPR and goodwill, and ensuring accurate TDS credit. The tribunal also clarified the treatment of provisions for warranty, obsolete inventory, and MSMED interest under normal provisions and Section 115JB, aligning with judicial precedents and statutory guidelines.