TaxTMI 
TaxTMI 
2018 (3) TMI 1199
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.... ITA/5575/Mum/2012, AY. 2002-03: 2. During the course of hearing before us, the Representatives of both the sides agreed that except for the Grounds No. 1, 2, 17 and 18 all the remaining grounds are covered-i. e. they stand decided in favour of the assessee or against it or have been set aside-by the orders for the Tribunal for the AY. s. 2008-09(ITA/586/Mum/2015), 1999-2000(ITA. s/2344 & 3037/ Mum/2009), 2000-01(ITA. s. 3998 & 4542/Mum/2010 and 2001-02(ITA. s7581 & 7846/ Mum/ 2011). GOA Issue Issue covered in favour /against assessee 3. Development expenses-Horizon III project expenses - tractor division - Rs. 8.96 crore (including staff cost, material of Rs. 4.67 crores dealt with separately . Against 3.a. In-house revenue expenditure- staff cost, material of Rs. 4.67 crores incurred as part of Development Projects Favour 4. Development Expenses -Euro II project of Rs. 47.66 lakhs Against 5. Technical services fees of Rs. 65, 00, 50, 757/- including staff cost, material of Rs. 15.55 crores Against 5.a In-house staff cost and material consumption of Rs. 15. 55 crore incurred as part of Development Project Favour 6. Exp....
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.... that the assessee had entered into following IT. s: SN. Nature of transaction Amount in (Rs. ) 1. Sale of tractors 87, 18, 40, 815/- 2. Sale of spare parts 3, 42, 57, 803/- 3. Reimbursement advertisement expenses 1, 35, 37, 809/- 4. Reimbursement of warranty expenses 1, 39, 53, 457/- She found that the assessee had benchmarked the export transactions and determined the ALP by applying cost plus method (CPM), that the IT. s were only in the tractor segment, that it had an installed capacity of Rs. 1. 12 lakhs tractors, that it could sell only 5, 684 units during the previous year resulting in under-utilisation of 48. 69% of its capacity, that it had sold 3, 153 tractors to MUSA, that it had sold tractors to other countries like Chilie, Romania, Tanzania, Egypt and SAARC countries namely Bangladesh, Nepal and Sri Lanka. She further found that the assessee had not considered all direct and indirect cost of production for determining ALP, that it had considered only variable cost including commission for benchmarking the IT. s, that it had made comparison at the net profit level and not at gross profit level, that it had compared net pro....
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....ee filed a detailed submissions before the TPO during the TP proceedings and stated that in order to function through its subsidiary in USA, it had to terminate the agency of two other third party US entities, that in accordance with the contractual relationship between the assessee and those entities, that it was required to pay a compensation at the rate of USD 100 for every Tractor sold in specified territories in USA. After considering the reply of the assessee, the TPO held that the assessee had considered only marginal costs for the purposes of applying the CPM, that it had excluded all fixed overhead, such as labour and manufacturing overheads, that such expenses were in the nature of variable costs, the assessee had not considered them as a part of its variable costs, that benchmarking undertaken by the assessee by considering the internal comparable transactions showed that it had earned a higher net profit margin on its transactions with third parties as against its transactions with the related party, that the sale of goods to AE and the pricing in that regard had consistently resulted in a loss to the assessee at the net profit level, that AE had made a profit at the ne....
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.... geographical differences, that TNMM was tolerant to measure product differences and minor functional differences, that if only value-added expenses were considered the profitability of the AE was 6. 9%, that the margin earned by the AE was not a valid argument, that quantity differences were not significant when CPM was applied. 4.3. Before us, the Authorised Representative(AR)stated that the assessee had referred to 3 comparables for bench-marking the transaction, that the arithmetic mean arrived at was 11. 7% as compared to 8. 24 % of the comparables, that the TPO adopted TNMM, that she rejected the method itself, that the addition made by her was not based on any logical principles. Referring to Cir. No. 2001 dtd 23/8/2001 issued by CBDT, he contended that the TPO had considered AE and non AE export, that export to US was 3153 units whereas export to other countries was 368 tractors only, that out of 368 units only 44 tractors were sold to Latin American and European countries, that rest of the units were sold to SAARC nations that comparing the SAARC nations with USA was not justifiable, that number of units would distort the margin, that sales made to Latin American countr....
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....quantitative adjustments. He relied upon the case of Wrigley India Private Ltd. (ITA/5648-50/Del/2012)and stated that geographical comparability was an important aspect while selecting the comparables, that as per rule 10 B (1)(c)(iii)of the Rules adjustments were to be made for functional and other differences between transactions and entities, that internal transactional net margin method was an invalid approach, that it was more logical to determine the ALP to external comparability analysis, that the comparable selected by the assessee was nearest available comparable, that function-al, geographical and economic differences were having material bearing on the prices, that method adopted by the TPO i. e. TNMM had to be rejected. He referred to the number of units manufactured and exported in the subsequent years and argued that market penetration and pricing policies of the assessee had worked in favour of the assessee. He further contended that the assessee might have suffered losses on full costing basis but it had made profits on marginal costing basis, that on US exports it had made gross contribution of Rs. 17. 78 crores which resulted in better absorption of fixed costs, t....
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....ransaction, or a number of such transactions, is determined ; (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market ; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii) ; (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise ;" From the above, it is clear that for applying CPM certain steps-determination of direct and indirect costs, determination of GP mark up of such costs, comparing it with unrelated enterprise in a comparable uncontrolled transaction, adjustment of GP mark up-have to be followed. 4.5. We find that the assessee had entered into four IT. s, that it claimed that reimbursement of advertisement and warranty expense were on actu....
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....ice of an international transaction. While it would be necessary to protect our tax base, there is a need to ensure that taxpayers are not to avoidable hardship in the implementation of these regulations. (emphasis added)" We find that the assessee had treated CPM as most appropriated method, whereas TPO applied TNMM for benchmarking the IT. s. It is true that the TPO is authorised to change the method for determining ALP of IT. s, if he can point out the defects in the method adopted by an assessee. In the case under consideration, we do not find any reasoned and justifiable finding has been given by the TPO for not following CPM. But, it is also true that the assessee had not followed all the steps as required by the provisions of Rule 10B(c)of the Rules. It is said that the object and purpose of TP adjustment is to ensure that the controlled taxpayers are given tax parity with uncontrolled taxpayers by determining their true taxable income. Costs or expenses incurred for services provided or in respect of property transferred, when made subject matter of the ALP by applying the CPM, cannot be again factored or included as a part of interconnected international transaction and....
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....s deduction u/s. 37 (1)/35 (1) of the Act. However, the AO held that advances to tractor division was a capital expenditure, that the transaction had no incidence on the profit and loss account, that the miscellaneous write-off was not allowable. Finally, he made a disallowance of Rs. 28. 06 lakhs. 5.1. Aggrieved by the order of the AO, the assessee preferred an appeal before the First Appellate Authority (FAA)and made submissions. After considering the available material, he held that disputed amount had been classified as capital expenditure by the auditors, that the contention of the assessee that such amount represented advances given in the normal course of business could not be accepted in view of the auditors' report. He confirmed the order of the AO. 5.2. During the course of hearing before us, the AR contended that the advances were given to various parties in the ordinary course of business in the earlier years, that advances became irrecoverable, that same were written off during the year under consideration, that the advances were made for development of tooling and related to the tractor division of Kandivili unit. He referred to the order of the Tribunal for the....
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....amati and later on finding the project uneconomical shelved the project, that the FAA disallowed the expenditure claimed by the assessee on the ground that the foundry had not been successfully set up. In our opinion, the installation of foundry cannot be taken as a pre-condition for allowing/disallowing the claim of an expenditure. What has to be seen is the real nature of the transaction. Foundry was an extension of the business of the assessee and directly related with its business. Considering unvaibility of a project, if an assessee drops the it, then it would not disentitle him from claiming the expenditure incurred for such aborted project. In the case before us, the expenditure was not incurred for a new project or new product totally disconnected with the business activities of the assessee. The assessee found that setting up of a foundry at Baramati would not be a profitable venture, so, it decided to discontinue it. It was a purely a commercial decision and every assessee has a right to manage his affairs in the manner he wants. Until and unless he does not violates the provisions of the Act, he can carry on his business and incur expenditure. The AO and the FAA have not....
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....te on the basis of empirical analysis, that the assessee used the historical data base for arriving at the warranty expendi - ture, that the provision for warranty expenses on the vehicles/tractors sold during the year was ascertained on the basis of actual expenses incurred on settlement of warranty claims in the earlier years and the actual sales made during the year, that such provisions were necessary to arrive at the on the basis of matching concept that provision for warranty had been allowed as deduction by the Tribunal while deciding the appeal for the assessment year 1989 - 90, that the provision for warranty was an ascertained liability. He referred to the case of Apollo Tyres Ltd. (255 ITR 273). The DR supported the order of the FAA and stated that he had already allowed the provision made for the labour demand, that provision for warranty was not an ascertained liability. 7.3. We have heard the rival submissions. Before proceeding further, we would like to refer to the case of Luk India Private Ltd. (347 ITR 674)the Hon'ble Madras High Court wherein it has dealt with the issue of provision for warranty vis-à-vis calculation under the MAT provisions. We are rep....
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....nt. of turnover of the company based on past experience (historical trend). The first option is unsustainable since it would tantamount to accounting for warranty expenses on cash basis, which is prohibited both under the Companies Act as well as by the Accounting Standards which require accrual concept to be followed. In the present case, the Department is insisting on the first option which, as stated above, is erroneous as it rules out the accrual concept. The second option is also inappropriate since it does not reflect the expected warranty costs in respect of revenue already recognized (accrued). In other words, it is not based on the matching concept. Under the matching concept, if revenue is recognized the cost incurred to earn that revenue including warranty costs has to be fully provided for. When valve actuators are sold and the warranty costs are an integral part of that sale price then the appellant has to provide for such warranty costs in its account for the relevant year, otherwise the matching concept fails. In such a case the second option is also inappropriate. Under the circumstances, the third option is the most appropriate because it fulfils accrual concept as....
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....Keeping in mind all the four aspects, we are of the view that the High Court should not to have interfered with the decision of the Tribunal in this case. " 4. A perusal of the principles stated therein shows that while there could be three broad options available to a company while making a provision, viz. , (a) account for warranty expense in the year in which it is incurred ; (b)it makes a provision for warranty only when the customer makes a claim ; and (c) it provides for warranty at 2 per cent. of the turnover of the company based on past experience (historical trend), the hon'ble Supreme Court while holding the first two options would not be appropriate, the third option would be more appropriate as that would fulfil the accrual concept as well as the matching concept. The hon'ble Supreme Court appreciated the decision of the company that while making a warranty provision based on past experience of the company, it held that there should be a warranty provisioning policy based on a scientific method and that if such provisions are made on experience and historical trend and if the working is robust, then the question of reversal in the subsequent two years, ....
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....eals). His orders for the assess ment years 1999-2000 to 2002-03 are, accordingly confirmed. " 6. We also perused the statements, which have been extracted by the Tribunal in its order in paragraphs 7 and 8. In fact, on behalf of the assessee, a categoric stand was made that the assessee was making a reasonable estimate of the provision for warranty claims and that it was consistently adopting a method of taking the average of actual settlements of the such immediately preceding three years while working out the provision based on the percentage of current year's sales. 7. Having regard to the figures furnished and the claim that a scientific approach was made while making a provision for warranty claim, which was based on the average of the previous years' warranty settlements, it cannot be held that there was any error, much less an illegal error committed by the Tribunal while passing the impugned order. In fact, a cursory glance of the figures set out in the statements in paragraphs 7 and 8 disclose that depending upon the trend of warranty settlements over a period of time corresponding to the sales figures, the percentage of provisions made was not i....
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.... foreign travel expenses in connection with the acquisition which did not materialize Against 4. Development expenses-Horizon II and IV project expenses-tractor division- Rs. 6.14 crore (including staff cost, material of Rs. 5.30 crores dealt with separately . Against 4.a. In-house revenue expenditure- staff cost, material of Rs. 5.30 crores incurred as part of Development Projects Favour 5. Development Expenses -Euro II project of Rs. 76.55 lakhs Against 6. Development expenses - Euro III project-Rs. 5.14 lakhs Against 7. Technical services fees of Rs. 53.49 lakhs Against 8. Disallowance u/s. 40A (9) - Rs. 7.37 lakhs Favour 9. Provision for warranty costs of Rs. 23.48 crore Set aside 10. Interest on income tax refund - Rs. 1.26 crore Against 8.1. Respectfully following the orders of the AY. s. 2006-0, 1999-00, 2000-01and2001-02 (supra), we decide grounds no. 3a. 4, 5, 6, 7 and 10 against the assessee, ground no. 9 is set aside and remaining grounds are decided in favour of the assessee. 9. First ground of appeal is about TP adjustment of Rs. 21. 29 crore. Following our order for the earlier AY. we dir....