Tribunal decides on transfer pricing methods and expense disallowances in international transactions

The Tribunal partly allowed the appeals by rejecting the use of the Berry Ratio and confirming the Resale Price Method (RPM) as the Most Appropriate Method (MAM) for determining the Arm's Length Price (ALP) in international transactions. The issue of disallowance of provisions for warranty expenses was remitted back to the Assessing Officer for verification based on historical data. The disallowance of delayed payments of Employees' contribution to PF and ESI was allowed by the Tribunal, citing a High Court judgment, subject to verification by the AO.

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Issues Involved:

1. Rejection of Comparable Uncontrolled Price (CUP) method for benchmarking international transactions.
2. Disallowance of provisions for warranty expenses.
3. Disallowance of delayed payments of Employees’ contribution to PF and ESI.

Issue-wise Detailed Analysis:

1. Rejection of Comparable Uncontrolled Price (CUP) Method:

The assessee, a subsidiary of Socomec SA France, engaged in importing and selling "Socomec" branded UPS in India, adopted the CUP method as the Most Appropriate Method (MAM) for determining the Arm's Length Price (ALP) of its transactions with its Associated Enterprises (AE). The Transfer Pricing Officer (TPO) rejected the CUP method, suggesting instead the Resale Price Method (RPM) or Berry Ratio. The TPO ultimately used the Berry Ratio, which is not a prescribed method under the Income Tax Act, leading to an adjustment of Rs. 11,64,40,050/- to the ALP of the imports. The TPO's rejection was based on the argument that the assessee added value to the products, making the Berry Ratio more appropriate. The Tribunal, however, found that the assessee did not add significant value to the UPS systems and that the RPM method, which compares the gross profit margin, was more suitable. The Tribunal rejected the TPO's application of the Berry Ratio and confirmed the use of RPM as the MAM.

2. Disallowance of Provisions for Warranty Expenses:

The assessee claimed provisions for warranty expenses amounting to Rs. 1,67,33,228/-. The lower authorities rejected this claim as the assessee did not provide historical trends or a systematic basis for the calculation. The Tribunal referred to the Supreme Court judgment in Rotork Controls India (P) Ltd., which allows such provisions if based on historical data and systematic maintenance. The Tribunal remitted the issue back to the Assessing Officer (AO) to verify if the provisions were made on a scientific basis and if excess provisions were reversed in subsequent years, in line with the Supreme Court's decision.

3. Disallowance of Delayed Payments of Employees’ Contribution to PF and ESI:

The assessee deposited Employees’ contributions to PF and ESI amounting to Rs. 1,54,892/- after the due date under the relevant Acts but before the due date for filing the income tax return. The AO disallowed this deduction under Section 2(24)(x) read with Section 36(1)(va) of the Income Tax Act. The Tribunal, however, referred to the jurisdictional High Court's judgment in CIT v. Industrial Security & Intelligence India Pvt. Ltd., which held that such contributions are allowable if paid before the due date for filing the return. The Tribunal allowed this ground subject to verification by the AO.

Conclusion:

The Tribunal partly allowed the appeals, confirming the use of RPM over the Berry Ratio for determining ALP, remitting the issue of warranty provisions back to the AO for verification, and allowing the deduction for delayed PF and ESI contributions subject to verification. The decisions were pronounced in April 2017, at Chennai.

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