2016 (5) TMI 1387

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....kets. The assessee was incorporated in 2005 and commenced its operations with distribution and marketing support services for UPS systems and accessories during the FY 2006-07. The assessment year under consideration is the first year of assessee's operation. The assessee imports finished goods (UPS systems and batteries) from its associated enterprises for resale in the domestic market. The products imported comprised of various categories/types of UPS systems. The asessee also performs certain marketing support services in connection with direct sales made by the associated enterprises to customers in India, for which it receives a commission income. The assessee had filed return of income declaring nil income. As the assessee had entered into various international transactions reference was made to transfer pricing officer for determination of arm's length price. The following are the details of international transactions with its associated enterprises as per Form 3CEB: S.No. Description of transaction Value (In Rs.) 1. Sales Promotion Expenses 1,09,188 2. Purchase of finished goods from AE 12,38,16,952 3. Rendering of Services (Commission Recd.....

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....gave following two directions: * For computing the operating income the commission income should be included both for the comparable companies as well as the assessee; * For computing the operating expenses, pre-operating expenses should be excluded. After these two directions the PLI of the assessee increased to - 31.03% (without including commission income) viz-a-viz the arm's length margin of 5.59% leading to an adjustment of arm's length price by Rs. 5,07,55,614/-. 7. The Assessing Officer, accordingly passed the assessment order u/s 143(3) read with section 144C on 19th October, 2011 determining the total income as under: Total loss as per computation of income (91,62,665) Add: (i) Addition on a/c of Transfer pricing adjustment 5,07,55,614 (ii) Claim of ROC expenses incurred in connection with increase in share capital 1,30,500 (iii) The expenses incurred in relation to start Of the business restricted to Rs. 10,90,815 10,90,815 (iv) Provision for warranty 16,99,465 5,36,76,394   Total income 4,45,13,729 8. Being aggrieved with the AO's order, the assessee is in appeal before us and has taken following grounds of....

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....d before the commencement of operations: Rs. 1,090,815 2.1 The ld. AO/DRP erred in confirming the disallowance of expenses incurred before commencement of operations as capital in nature. 2.2 The ld. AO/DRP ought to have observed that said expenses were incurred wholly and exclusively for the purpose of business of the appellant and therefore, allowable u/s 37(1) of the Act. 2.3 Notwithstanding and without prejudice to above, should the said expenditure be treated as capital in nature, the ld. AO erred in not granting the deduction u/s 35D of the Act. 3. Disallowance of provision for warranty: Rs. 1,699,465 3.1 The ld. AO/DRP erred in confirming the disallowance of provisions towards warranty made by the appellant as a percentage of sales made during the year based on technical estimate. 3.2 The ld. AO/DRP ought to have observed that the appellant follows scientific basis and a consistent policy while making provision for warranty. 3.3 The ld. AO/DRP ought to have observed that the expenses are incurred wholly and exclusively for the purpose of business of the appellant and is therefore, allowable u/s 37(1) of the Act. 3.4 The ld. AO/DRP erred in not followi....

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....stated as under: "The assessee wishes to highlight to the Hon'ble DRP Panel that the ld. TPO has not appreciated the fact that FY 2006-07 was assessee's first year of business operations. The ld. TPO has not performed appropriate adjustments in this respect to the financials of the comparable companies (for e.g. V Guard is into 12th year of operations in FY 2006-07 and P.L. Enterprises is into 16th year of operations in FY 2006-07). The ld. TPO should have ideally examined and considered the results of first year of operations of the TPO selected comparables. The assessee would like to humbly submit that the net loss incurred by the assessee during FY 2006-07 is not as a result of higher transfer price determined for the international transaction relating to purchase of goods, but is primarily due to the fact of certain extraordinary and fixed costs incurred during the first year of operations of business, which will be true even in case of the comparables. The detailed working in this regard would be produced by the assessee at the time of hearing before the Hon'ble DRP." 10.1 With reference to the abvoe objections raised before ld. DRP, ld. Counsel pointed out that thoug....

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....me to the fixed cost. Unless the fixed cost is fully recovered, the break even cannot be arrived at. 14.2 Under such circumstances, the losses incurred by the assessee cannot be the basis for finding out the arm's length price without making due adjustments to the operating expenses so as to bring it at the level playing field with the comparables. In the course of hearing the ld. Counsel pointed out that break even was arrived at in next year and ld. TPO has accepted the transactions being at arm's length price in next year. One of the contentions of the ld. CIT DR was that this plea was not taken before ld. TPO but, as reproduced earlier, before ld. DRP, specific objection to this effect had been taken. Therefore, merely on the ground that this plea was not taken, assessee's claim cannot be denied more particularly because not allowing for this adjustment would go against the very principle of comparability criteria contemplated under Rule 10B of the I.T. Rules. We further find that though ld. DRP had given direction for inclusion of commission income as part of the operating income but except PAE Ltd. all other comparables were not having any commission income. 14.3 Under ....

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....2 are that during the assessment proceedings the AO noticed that assessee had incurred recruitment expenses of Rs. 20,58,421/-, training expenses of Rs. 14,25,845/- and entertainment expenses of Rs. 30,48,460/-. He pointed out that this was the first year of assessee's business and the assessee had incurred all these expenses to start its business. He noticed from the details of entertainment expenses that they had been incurred for the launch of the business of the assessee at various stations like Hyderabad, Pune, Kolkata, Mumbai, Delhi etc. After examining the details he concluded that all these three expenses aggregating to Rs. 65,32,726/- were capital in nature. 21. Ld. DRP relying on the decision in the case of EID Peri (India) Pvt. Ltd. vs. CIT, 257 ITR 253 (Mad.) held that these were pre-operative expenses incurred by assessee prior to the (commencement of the business dt. 11th May, 2006) and, therefore, directed to restrict the disallowance to Rs. 10,90,815/-. 22. Ld. Counsel submitted that ld. DRP has not considered the set up aspect of the business as has been clarified in the case of CIT vs. Saurashtra Cement Industries (91 ITR 170) & 26 ITR 151 (Mum.) (HC) Wester....