2020 (3) TMI 471 - AT - Income Tax

Tribunal directs Transfer Pricing Officer to reconsider method & transactions, allows warranty provision deduction.

M/s Lenovo India Pvt. Ltd. Versus The Income Tax Officer, Ward - 4 (1) (1) Bangalore.

The Tribunal partially allowed the Assessee's appeal by directing the Transfer Pricing Officer to apply the Comparable Uncontrolled Price method for ... TP Adjustment - MAM selection - contention of the Assessee that CUP should have been accepted as the MAM - HELD THAT:- We direct the TPO to apply CUP as the MAM and determine ALP after due opportunity of being afforded to the Assessee. Treatment of alleged excess AMP expenditure pertaining to trading segment as an international transaction - determining the ALP and making the consequent addition to the total income of the assessee TPO adopted Resale Price Method (RPM) as the most appropriate method - HELD THAT:- it would be just and appropriate to set aside the issue of determination of net margin of the assessee and in the trading segment, as claimed by the assessee in Scenario-3 before the TPO. If the margins are accepted as at arm’s length and then applying the principles laid down by the Hon’ble Delhi High Court in the case of Sony Ericsson Mobile Communications India P. Ltd. [2015 (3) TMI 580 - DELHI HIGH COURT] incurring of AMP expenses cannot be treated as international transaction and consequently determination of ALP would not arise for consideration at all. We therefore set aside the order of the AO and remand the issue to the TPO for consideration of ALP of the trading segment applying the net profit margin method and if by such method the price received in the international transaction is considered as at arm’s length, then no separate addition needs to be made. Determination of ALP in respect of price received by the assessee from its AE for providing sales facilitation services and for providing administrative and business support services - HELD THAT:- Due to increasing presence of composite contracts and ‘package deals’ in an MNE group, the aggregation of transactions become necessary as a composite contract may contain a number of elements including royalties, leases, sale and licenses all packaged into one deal. One would usually want to consider the deal in its totality to understand how various elements relate to each other, but the components of the composite package deal may or may not, depending on the facts and circumstances of each case, need to be evaluated separately to arrive at the appropriate transfer price. Aggregation issue may also arise when looking at uncontrolled comparables. This is because third party information is not often available at the transaction level. In such circumstances, entity level information is the only recourse available. Therefore, whether ALP-principle is to be applied on a transaction by transaction basis or on an aggregation basis depends on the facts of each case and is not universally or generally applied in all composite contracts involving multiple transactions. Since this specific objection of assessee has not been met by the TPO/DRP, we deem it fit and proper to set aside the order of AO in this regard and remand the matter to the TPO for fresh consideration of the question, whether international transactions can be aggregated in the given facts and circumstances. If aggregation is not possible, then the ALP of the sales facilitation services segment and administrative & business support services segment should be determined separately. The assessee will be afforded opportunity of being heard in this matter. In view of the above, the other grounds related to manner of determination of ALP by aggregating the above two transactions does not require consideration at this stage. Disallowing provision for warranty - HELD THAT:- The hypothetical computation by the revenue authorities of percentage of actual claim for the year and provision made for the very same year, cannot be sustained because the basis of providing warranty is Machine months x repair rate x cost per claim. The tribunal has already pointed out the flaw in the approach of the revenue authorities in its order for AY 2006-07 that the basis should be the actual expenditure incurred on discharge of warranty claims in future which is much more than the provision made in an earlier year. The warranty obligation is not just for one year and it spreads over a period of more than 1 year and therefore the comparison as done by the revenue authorities is unsustainable. The method followed by the Assessee for creating provision for warranty has been held to be scientific and based on historical data of sales and repair ratio in every region in which the products are sold. The method has been accepted by the Tribunal in its order for several AYs. The method followed has not been shown to be not scientific by the revenue authorities. In such circumstances, we are of the view that the method followed by the Assessee should be accepted as proper and the deduction allowed as per the provision created by the Assessee. Addition made to the book profits u/s.115JB on account of provision for warranty liability - Addition treating the same to be a liability of a contingent nature and hence liable to be added to the profit as per profit and loss account prepared in accordance with companies act to arrive at the book profit of the Assessee for the purpose of levy of tax on book profit under Sec.115JB - HELD THAT:- As already held that the provision for warrant expenses is not contingent and has to be allowed as deduction while computing income under the head “Income from Business & Profession”. As a consequence of such finding, the addition made to the book profits is to be deleted because the liability cannot be said to be contingent. Issues Involved:1. Transfer Pricing (TP) adjustment in the manufacturing segment.2. Rejection of Internal Comparable Uncontrolled Price (CUP) Method.3. Adoption of Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM).4. TP adjustment on account of alleged excess Advertising, Marketing, and Promotion (AMP) expenditure in the trading segment.5. Aggregation of Sales Facilitation Services and Administrative & Business Support Services.6. Disallowance of Provision for Warranty.7. Addition of provision for warranty to the book profits.Detailed Analysis:1. Transfer Pricing (TP) Adjustment in the Manufacturing Segment:The Assessee contested the TP adjustment of INR 7,96,04,375 made by the AO/TPO, asserting that the international transactions with its Associated Enterprises (AEs) were at arm's length. The Assessee used the Internal CUP method to benchmark the import of raw materials. The TPO rejected this method and adopted the TNMM, resulting in an addition of INR 67,09,25,862. The Tribunal directed the TPO to apply the CUP method as the MAM, as it was upheld in previous years for the Assessee. The Tribunal concluded that CUP should be adopted as the MAM and directed the TPO to determine the ALP accordingly.2. Rejection of Internal Comparable Uncontrolled Price (CUP) Method:The TPO rejected the CUP method citing the lack of reliable data, use of weighted average prices, and non-availability of publicly available information. The Assessee argued that the CUP method was consistently accepted in previous years and provided detailed explanations and precedents supporting the method's appropriateness. The Tribunal agreed with the Assessee, emphasizing that the facts and circumstances had not changed from previous years, and directed the TPO to apply the CUP method.3. Adoption of Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM):The TPO adopted TNMM as the MAM for benchmarking the international transaction of import of raw materials, which was contested by the Assessee. The Tribunal found that the CUP method should be applied as the MAM, consistent with previous years' decisions, and directed the TPO to determine the ALP using the CUP method.4. TP Adjustment on Account of Alleged Excess Advertising, Marketing, and Promotion (AMP) Expenditure in the Trading Segment:The Assessee challenged the TP adjustment of INR 1,18,60,27,058 related to AMP expenditure, arguing that the expenditure was not an international transaction. The Tribunal referred to the Delhi High Court's decision in Sony Ericsson Mobile Communications India P. Ltd., which held that AMP expenses cannot be treated as a separate international transaction if the TNMM is accepted. The Tribunal remanded the issue to the TPO to determine the ALP of the trading segment using the net profit margin method. If the net margins are at arm's length, no separate addition for AMP expenses is required.5. Aggregation of Sales Facilitation Services and Administrative & Business Support Services:The TPO aggregated the sales facilitation services and administrative & business support services segments for determining the ALP, which was contested by the Assessee. The Tribunal highlighted that transfer pricing should ideally be done on a transaction-by-transaction basis, and aggregation should be considered only if transactions are closely linked. The Tribunal remanded the matter to the TPO to reconsider whether the transactions can be aggregated and, if not, to determine the ALP separately for each segment.6. Disallowance of Provision for Warranty:The Assessee claimed a deduction for the provision for warranty amounting to INR 73,93,02,026, which was disallowed by the AO. The Tribunal referred to the Supreme Court's decision in Rotork Controls India Pvt. Ltd., which laid down principles for determining whether a liability is contingent or actual. The Tribunal found that the Assessee's method for creating the provision was scientific and based on historical data. The Tribunal directed the AO to allow the deduction for the provision for warranty.7. Addition of Provision for Warranty to the Book Profits:The AO added the provision for warranty to the book profits, treating it as a contingent liability. The Tribunal held that since the provision for warranty was not contingent and was allowed as a deduction under business income, it should not be added to the book profits. The Tribunal directed the AO to delete the addition made to the book profits.Conclusion:The Tribunal allowed the appeal of the Assessee in part, directing the TPO to apply the CUP method for determining the ALP, reconsider the aggregation of transactions, and allow the provision for warranty as a deduction. The Tribunal also directed the AO to delete the addition made to the book profits on account of the provision for warranty.