TaxTMI 
TaxTMI 
2020 (3) TMI 471
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....anel ("DRP") under section 144C(5) and the order passed by the learned Transfer Pricing Officer ("TPO") under section 92CA of the Act are not in accordance with the law and made in violation of the principles of equity and natural justice and are contrary to the facts and circumstances of the present case. II. TP adjustment of INR 7,96,04,375 in relation to manufacturing segment: 2. The Honourable DRP and the learned AO / TPO have erred in law and on facts in making transfer pricing ("TP") adjustment of INR 7,96,04,375 to the returned income of the Appellant and in holding that the international transactions undertaken by the Appellant with its associated enterprises ("AEs") in the manufacturing segment were not at arm's length. Rejection of Internal Comparable Uncontrolled Price Method adopted as the most appropriate method by the Assessee: 3. The Honourable DRP and the learned AO / TPO have erred in law by rejecting the application of Internal Comparable Uncontrolled Price ("Internal CUP") method selected as the most appropriate method ("MAM") by the Appellant for benchmarking the international transaction of import of raw materials in rela....
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....nd thereby not considering the detailed submissions of the Assessee: a. VXL Instruments Limited b. CCS Infotech Limited 11. The Honourable DRP and the learned AO / TPO have erred in law by not granting appropriate favourable economic adjustments (including the working capital adjustment) while calculating the arm's length margin for final set of comparable companies under the TNMM for the manufacturing segment. III. TP adjustment of INR 1,18,60,27,058 on account of alleged excess AMP expenditure pertaining to trading segment: 12. The Honourable DRP and the learned AO / TPO have erred in law and on facts, in making TP adjustment of INR 1,18,60,27,058 to the returned income of the Appellant by assuming the existence of an alleged international transaction of brand promotion services to AE and alleging the same to be not at arm's length in terms of the provisions of sections 92C(1) and 92C(2) of the Act read with Rule 10D of the Income tax Rules, 1962 ("the Rules"). AMP expenditure not an international transaction, 13. The Honourable DRP and the learned AO / TPO have erred in law and on facts by alleging that the u....
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....he Appellant for the purpose of its business cannot as a deemed international transaction under section 92B(2) of the Act. 20. The Honourable DRP and the learned AO / TPO have failed to appreciate that the Appellant has been uninterruptedly using the said brand for the last several years and till date, thus, all benefits endured to the Appellant, for which the Appellant has not even been paying any royalty to its AE. Consequently, for all purposes the Appellant is the sole beneficiary of all the benefits of AMP expenditure incurred during financial year ending 31 March 2015. 21. The Honourable DRP and the learned AO / TPO have erred in law and on facts, by holding that the Appellant by incurring excessive AMP expenditure has resulted in creation of marketing intangible in favor of the AE, for which it should be compensated by the AE. 22. The Honourable DRP and the learned AO / TPO have erred in law and on facts by disregarding judicial pronouncements in undertaking TP adjustments in relation to AMP. Notwithstanding and without prejudice to the above grounds that the AMP expenditure incurred by the Appellant does not constitute an international tr....
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.... to the intensity of AMP functions of the Appellant for computing the AMP/Sales ratio and thereby considered companies that have very low AMP/Sales ratio. 27. The Honourable DRP and the learned AO / TPO have erred in law and on facts in concluding that the distribution and AMP are two distinctive functions and requires to be remunerated separately. 28. The Honourable DRP and the learned AO / TPO have erred in law and on facts by characterizing the incurrence of AMP expense as a provision of brand promotion services by the Appellant to its AE requiring a mark-up. 29. The Honourable DRP and the learned AO / TPO have erred in law and on facts in not appreciating that the Appellant has not provided any value added / brand building services to its AE by incurring AMP expenses, and therefore, no mark-up could have been charged / levied on such expenses, even if the same was to be characterized as an 'international transaction'. 30. The Honourable DRP and the learned AO / TPO have erred in not appreciating that in view of the Appellant being contractually assured of a margin after cost recovery, the entire AMP expenditure has in fact been recove....
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....ness Support Services segment 35. The Honourable DRP and the learned AO / TPO have erred in law and on facts in making TP adjustment of INR 14,99,86,652 to the returned income of the Assessee and in holding that the international transactions undertaken by the Assessee with its AEs in the Sales Facilitation Service segment and Administrative and Business Support Services segment were not at arm's length. 36. The Honourable DRP and the learned AO / TPO have erred in law and on facts in undertaking a composite benchmarking for both the segments and thereby failing to appreciate that the services rendered by the Appellant to its AEs in each of these segments are separate and distinct and accordingly needs to be benchmarked separately. 37. The Honourable DRP and the learned AO / TPO have erred in law in rejecting the TP documentation of the Appellant as "not reliable or correct", under section 92C(3) of the Act, merely because the learned TPO did not agree with the positions and filters adopted by the Assessee in its TP documentation, and adopted certain additional filters / modified filters in selecting the comparable companies by using non contemporaneo....
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....nt. 46. The Honourable DRP and the learned AO have erred in law by not following the order of the Honourable ITAT in the Appellant's own case for the AY 2006-07, AY 2007-08, AY 2010-11 and AY 2011-12, wherein it was held that the provision for warranty has been created on a scientific basis and that the same should be allowed as a deduction. 47. The Honourable DRP and the learned AO have not appreciated the fact that the Appellant maintains its books on a mercantile basis of accounting and that the said warranty provision has been created on a scientific manner followed consistently over the years, having due regard to the nature of activity, its global warranty accrual processes and the industry requirement in which the Appellant operates. 48. The Honourable DRP and the learned AO have erred on facts in failing to consider that the Appellant has provided for warranty on a scientific and consistent manner every year applying the principles laid out by the Honourable Supreme Court ("SC") in the case of Rotork Controls India Privat and therefore such expenditure is an allowable deduction under section 37 of the Act. 49. The Honourable DRP and t....
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....cific adjudication. 4. Ground No.II raised by the revenue is in relation to determination of Arm's Length Price in respect of an international transaction of import of parts and components from its Associated Enterprise (AE). The Assessee is a company incorporated in India. It is engaged in the business of trading, manufacture and sale of desktops, laptops, servers and smartphones. It has a manufacturing facility in Pondicherry, India. 5. During the FY 2014-15, the assessee imported certain parts and components from its Associated enterprises ("AEs") for purpose of manufacturing of Personal Computers (PCs). The transaction of import of parts and components was an international transaction and therefore income from such international transaction has to be determined have regard to Arm's Length Price (ALP) as laid down in Sec.92 of the Income Tax Act, 1961 (Act). The Assessee also imported parts and components from third parties. The methodology adopted by the Assessee for benchmarking the price paid to the AE for import and components was as follows: Nature of international transaction MAM Value as per books of accounts ALP as determined by Assessee Remarks I....
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....the prices paid for these imports have been considered to be at ALP. With respect to remaining 65 products that did not fall within the arm's length price, it was the case of the Assessee that the difference from the ALP is not material and the Assessee did not undertake any further analysis for such differences. However, suo-moto adjustment of INR 21,616,741 was made in the Return of Income. 6. The Transfer Pricing Officer (TPO) to whom the question of determination of ALP was referred to by the Assessing Officer (AO) u/s.92CA of the Act, did not accept the aforesaid TP analysis for the reasons given in his show cause notice(SCN) to the AO dated 26.9.2018. In the said SCN, the TPO firstly, expressed his opinion that for applying CUP method, reliable data is required for comparing controlled transaction with an uncontrolled transaction and such reliable data was not available. The reply of the Assessee in this regard was that each of the component/parts were identified with a unique identification number and the details were captured in the TP Analysis. The second objection of the TPO was that the Assessee used weighted average of price of components/parts imp....
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.... the Assessee for benchmarking the subject transaction in AY 2006-07 to AY 2009-10 and AY 2010-11. Copies of ITAT Orders with clear findings for these years was also filed before the TPO. 8. The TPO however applied the Transaction Net Margin Method (TNMM) as the MAM and determined ALP which resulted in an addition of Rs. 67,09,25,862 to the total income of the Assessee in the draft assessment of the AO. The Assessee filed objection to the proposed addition before the Dispute Resolution Panel (DRP) but the DRP upheld the order of the TPO. The DRP upheld the order of the TPO by observing that in CUP method strict comparability is required and such comparability is not possible in the case of the Assessee. The DRP also upheld application of TNMM as MAM and methodology adopted to determine ALP under the TNMM by the TPO. 9. Aggrieved by the order of the DRP, the Assessee has raised Grd.No.II before the Tribunal. We shall first take up Gr.No. II sub grounds 2 to 6 which grounds relate to the contention of the Assessee that CUP should have been accepted as the MAM. We have heard the rival submissions. As far as the issue of MAM in the case of the Assessee in the transaction of impor....
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....ut details of product, its specification etc. According to assessee, the aforesaid advertisement and business promotion activities undertaken by the assessee are specific to the products sold in India. It was the contention of assessee that in the trading segment of desktop, laptops etc., it decides on advertisement, training etc. According to the Assessee the expenditure so incurred was to improve its sale and it cannot be said that by incurring such expenses, the assessee promoted the brand of its foreign AE. It was the case of revenue that assessee did not confine itself to distribution of trading goods, but has performed additional functions in the form of advertisement and marketing promotion to promote the brand of foreign AE and therefore the assessee needs to be adequately compensated for such additional function. The TPO adopted Resale Price Method (RPM) as the most appropriate method. The TPO chose 9 comparable companies and arrived at the AMP to sales of those companies and compared the same with that of the assessee. By such comparison, the TPO came to the conclusion that assessee was incurring much higher AMP expenditure than the industry average and incurring of ex....
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.... that taxpayer's PLI was 13.08%. In the TP order, the TPO did not make any adjustment in the trading segment and therefore it is presumed that he has accepted the transaction of trading with the AE as at arm's length. The ld. counsel for the assessee submitted that following the decision of the Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communications India P. Ltd. (supra), incurring of AMP expenses cannot be regarded as an international transaction at all. 16. The Bench queried that in the case decided by the Hon'ble Delhi High Court, TNM Method was adopted whereas in the case of assessee in the trading segment RPM has been adopted and that would make a difference. The ld. counsel for the assessee firstly pointed out that the AMP addition on account of determination of AMP expenses has been made only in the trading segment and in this regard drew our attention to an order dated 14.11.2018 passed by the TPO u/s. 154 of the Act wherein the fact that AMP expenditure is in relation to trading segment only has been accepted by the TPO. His next submission was that the assessee has also demonstrated in its TP study with regard to the trading segment that the net mar....
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....ices at page 169 of the PB and that with regard to sales support services is at page 174 of PB. It was the plea of assessee that the FAR analysis of both these segments were different and cannot be aggregated as one transaction. The DRP, however, did not deal with the aforesaid objection at all. 19. We have considered the rival submissions. As per the Indian Income-Tax Act, ideally, the transfer pricing is to be made on a transaction by transaction basis. However, Rule 10A(d) provides that the term 'transaction' includes a number of closely linked transactions. Thus, in cases where separate transactions are so closely linked or are closely inter-related or continuous and where application of the arm's length principle on a transaction by transaction basis becomes cumbersome for all involved and would not lead to an accurate result, recourse is often had to evaluate transactions following an 'aggregation' principle. 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. ....
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.... Amount ( in I) Opening balance 154,82,86,076 Provision made during the year 259,83,13,924 Utilisation 147,92 55,949 Closing balance 266,73,44,051 23. As can be seen from the aforesaid table, the actual liability incurred on account of warranty liability during the year was Rs. 147,92,55,949/-. The warranty period is one to four years and the warranties are against manufactured and other defects as per the terms of contracts(s) with the customer. The warranty is disclosed as a contingent liability in the balance Sheet as required by Accounting Standard-29 (AS-29) issued by the Institute of Chartered Accountants of India (ICAI). The assessee vide letter dated 20/11/2018 submitted that the warranty provision has been created as per Accounting Standard 29 and is based on the scientific formula as explained below:- Machine months X Repair rate X Cost per claim Where: Machine months is the factor of the unexpired warranty period in months and the number of PCs which are under warranty at the end of the year; Repair rate is the percentage of claims out of the total sales made on the historical data for the region; and ....
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....ined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits; (3) A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise that is recognized as provision. For a liability to qualify for recognition there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement, is determined by considering the said obligations as a whole; (4) In the case of a manufacture and sale of one single item the provision for warranty could constitute a contingent liability not entitled to deduction u/s 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units ....
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....erefore, a prudent businessman would always keep something against the rainy-day but such saving should not be so big and high that allegation of unjust enrichment could be leveled against such businessman. In other words, extremes should be avoided. Therefore, a ratio of 70 % or round figure 70:100 between the actual expenditure and the provision. Reversely, the ratio 140:100. In other words, the total provision including the opening balance should be around 140% of the actual expenditure. He thereafter tabulated the ratio between the actual expenditure and the provision and found that the ratio in the case of the Assessee was around 279:100 which according to him was highly disproportionate. He observed that the average ratio is also worked out for the earlier years and it has always been around 238:100 or more. He therefore concluded that the warranty provision created by the Assessee was unscientific and therefore unascertainable. The AO also co-related year-wise sales turnover with that of warranty provision created and utilized and came to the conclusion that sales/turnover increased from Rs. 1044.24 crores in FY.2005-06 to Rs. 1805.40 crores in FY.2007-08. Subsequently, ther....
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....(Rs. 259,83,13,924 - 147,92,55,949) was disallowed and added to the income. 28. Before DRP apart from pointing out that in the earlier AYs the Tribunal has allowed similar claim of the Assessee, the Assessee pointed out the following factual details regarding the AO having considered incorrect amount of provision for warranty created during the year amounting to INR 259,83,13,924. However, the amount debited to the statement of profit and loss towards warranty expenses for the FY 2014-15 is only INR 221,85,57,975, as appearing in Note 25 of the audited financial statements (relevant page of the financial statement attached as Annexure -21). The Assessee also submitted that the provision for warranty created during the year of INR 259,83,13,924, as appearing in the balance sheet of Lenovo India as on March 31, 2015, includes an amount of INR 37,97,55,949, which pertains to provision for warranty on acquisition of business from IBM India Private Limited as a going concern, as mentioned in Note 26 and Note 45 of the audited financial statements (relevant page of the financial statement attached as Annexure 22). The Assessee thus pointed out that an amount of INR 37,97,55,949 has no....
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....warranty in a scientific manner. It is not disputed that in the impugned assessment year it had started doing the business of sale of laptops and desktops. Obviously assessee had no historical data with it. It is also not disputed that assessee had taken over this business from IBM, who had substantial experience in such business. Hence if the assessee relied on the methodology followed by IBM for working out the warranty provision we cannot say that it was incorrect. There is no case for the Revenue that any provisioning made by IBM in respect of such business in any earlier years were disallowed for a reason that it was unscientific. It is true that assessee had adopted two factors namely, repair action rate and cost per claim from IBM data available at Asia Pacific Level. It might also be true that assessee had not produced records relating to IBM to show that these rates were correctly worked out by IBM. Nevertheless a look at the warranty provisioning table of the assessee for the succeeding assessment years reveals the following : There is much strength in the argument of the Ld. AR that provision done for a year should be compared with the actual spending i....
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....e 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. We hold and direct accordingly. 35. As far Gr.No.VII raised by the Assessee is concerned, the same relates to addition made to the book profits u/s.115JB of the Act on account of provisio....