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2017 (4) TMI 1261 - AT - Income TaxDisallowance of product development - nature of expenses - revenue or capital expenditure - Held that - In the first round of assessment proceedings the said expenditure was connected with the expenditure incurred in the first year of commencement of business on product development and hence, the expenditure was held to be capital in nature. However, where expenditure on testing of the product which is required to be incurred on a regular basis and which does not result into creation or acquisition of any assets, then there is no merit in holding the expenditure to be of enduring benefit. The assessee is carrying out this exercise of modification and improvisation in the products in order to test suitability in the environment in which it is to be used and hence, the said expenditure is duly allowable in the hands of the assessee as revenue expenditure. The bill wise nature of expenses are tabulated at page 6 of the order of CIT(A) and perusal of the same reflects expenditure to be revenue in nature. Once, the expenditure has not been incurred for the development of new product but is for the improvisation of the products already being manufactured by the assessee, then such an expenditure which is a regular expenditure incurred by the assessee for smooth and efficient working of its business, is to be allowed as revenue expenditure in its hands - Decided against revenue. TPA - selection of comparable - Held that - In the IT Enabled Services Division, the assessee was providing services to its parent company in Germany and was a limited scope service provider, thus companies functionally dissimilar with that of assessee need to be deselected from final lit of comparable. Allocation of lease line cost to two segments operated by the assessee i.e. manufacturing segment and ITES segment - Held that - The assessee had estimated the use of two lines out of six lines for Design Engineering Segment i.e. about 40% of the lease line cost. However, the TPO and the CIT(A) were of the view that 80% of the total cost was attributable to Design Engineering Segment. The case of the assessee was that it had consistently followed the said allocation procedure on the basis of usage and since out of six lines, two lines were used by ITES segment, then there was no need to disturb the same. The assessee was operating both the segments and where the assessee had consistently followed a basis for allocation of the lease line cost, then there is no merit in adhoc apportionment of the said cost basis. Hence, we reverse the orders of TPO and the CIT(A) in this regard and allow the ground raised by the assessee. Disallowance of provision for warranty - Held that - Direct the Assessing Officer to allow the claim of the assessee vis- -vis provision for warranty. See case of Thermax Babcock & Wilcox Ltd. 2001 (5) TMI 173 - ITAT PUNE .
Issues Involved:
1. Deletion of disallowance of product development expenses. 2. Classification of product development expenses as revenue expenditure. 3. Adjustment to Arm's Length Price (ALP) in Transfer Pricing. 4. Deduction claimed for incremental provision for warranty. 5. Allocation of leased line cost to different segments. 6. Exclusion of certain comparables in Transfer Pricing analysis. 7. Risk adjustment in Transfer Pricing. Detailed Analysis: 1. Deletion of Disallowance of Product Development Expenses: The Revenue challenged the deletion of disallowance amounting to ?42,21,665/- for product development expenses. The Tribunal noted that the expenditure was incurred for testing and validation of products, which is a regular requirement for maintaining product quality and market suitability. The Tribunal upheld the CIT(A)'s decision, stating that such expenses are revenue in nature as they do not result in the creation or acquisition of any assets. 2. Classification of Product Development Expenses as Revenue Expenditure: The Tribunal held that the expenses incurred by the assessee for product testing and validation were necessary for the regular improvement and modification of products. These expenses were deemed to be revenue in nature as they were incurred for the smooth functioning of the business and did not provide any enduring benefit. The Tribunal dismissed the Revenue’s appeal, supporting the CIT(A)'s view that the expenses were allowable as revenue expenditure. 3. Adjustment to Arm's Length Price (ALP) in Transfer Pricing: The assessee and the Revenue both filed appeals regarding the ALP adjustments. The Tribunal upheld the CIT(A)'s decision that TP adjustments should be restricted to the value of international transactions and not the total turnover, citing the Hon’ble Bombay High Court's decision in Commissioner of Income Tax Vs. ALSTOM Projects India Limited. The Tribunal also directed the Assessing Officer to include depreciation and duty drawback in the operating costs and revenues for a fair comparison. 4. Deduction Claimed for Incremental Provision for Warranty: The Tribunal reversed the CIT(A)'s decision and allowed the assessee's claim for deduction of incremental provision for warranty amounting to ?31,37,190/-. The Tribunal noted that the provision was made on a scientific basis and consistently followed by the assessee, aligning with the Supreme Court's decision in Rotork Controls India P. Ltd. Vs. CIT. 5. Allocation of Leased Line Cost to Different Segments: The Tribunal addressed the allocation of leased line costs between the manufacturing and ITES segments. The Tribunal accepted the assessee's consistent method of allocating 40% of the total leased line cost to the ITES segment, reversing the TPO and CIT(A)'s decision to allocate 80%. 6. Exclusion of Certain Comparables in Transfer Pricing Analysis: The Tribunal admitted the assessee's additional ground to exclude Banco Products (India) Limited from the list of comparables, noting that the company was engaged in diversified activities without segmental details. The Tribunal remitted the issue back to the Assessing Officer/TPO for verification. The Tribunal also excluded Public Sector Enterprises like Engineers India Ltd., KITCO, and WAPCOS from the list of comparables, citing their distinct risk profiles and social obligations. 7. Risk Adjustment in Transfer Pricing: The Tribunal directed the Assessing Officer to allow risk adjustment in the Design Engineering Services segment, following the precedent set by the Delhi Bench of Tribunal in the case of Sony India Pvt. Ltd. The Tribunal emphasized that the assessee, being a risk-mitigating entity, should be granted risk adjustment while benchmarking its international transactions. Conclusion: The Tribunal upheld the CIT(A)'s decisions on several counts, including the classification of product development expenses as revenue expenditure and restricting TP adjustments to international transactions. The Tribunal also allowed the assessee's claims for deduction of warranty provisions and proper allocation of leased line costs, while remitting certain issues back to the Assessing Officer for further verification. The appeals of the Revenue were dismissed, and the assessee's appeal was partly allowed.
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