2017 (2) TMI 1415 - AT - Income Tax

TP Adjustment - transaction related to Contract revenue from projects - MAM selection - assessee adopted Cost Plus Method (CPM) as the most appropriate method with GP margin as the appropriate Profit Level Indicator (PLI) - whether the assessee has justified for considering the aggregation of all the projects with AE (the AEs are different) and compared the mean CPM of the projects of related party transactions? - HELD THAT - Since the projects are operating in different life cycles with different level of completions, it would be more appropriate to compare the margin on an aggregate basis as project- wise one-on-one comparison is not possible and would give distorted results. We are also aware of the nature of business of the assessee. The overall profitability of the projects depends upon various factors such as nature of work, bidding process, location etc. Therefore, we are of the view the TPO/DRP was in error in comparing individual projects margins of transaction with AE with aggregate margins earned from transaction with Non AE s which is improper as individual margins are being compared with aggregate margin which is impermissible under law. We find that in the case of the assessee, there are long- term contracts for supply of commodities, and separate transactions are closely linked or continuous that they cannot be evaluated adequately on a separate basis as per examples given in the light of OECD Guidelines para 1.42 as quoted above, we are, therefore, of the view that the combined approach of transaction and aggregation of transaction is the most appropriate method. Contracts of the assessee with AEs run over a period of 2 to 4 year and as such are long-term contracts justifying as a combined transaction approach as taken by the assessee. We also observe that the assessee had earned lower than mean gross margin in some individual unrelated party transactions also. Therefore, comparing margin of individual contracts with AE s with margin calculated the average margins entered with Non AE s does not appear to be as per the principal of transfer pricing. The assessee is a risk bearing entity and is full of risk bearing manufactures and supply of all power generation equipment s and as such the assessee is likely to earn low gross margins on international transactions based on the quotient of risk involved. The same is also evident from the fact that the assessee has earned lower than mean gross margins in unrelated party transactions also. The margin using TNMM method for the assessee for transaction with AE was determined at 10.01% compared to 6.66% for transactions with Non AE s. We also find that this contention of the assessee was also accepted by the Hon ble ITAT in earlier years (i.e. A.Y. 2006-07 ,2007-08, and 2009-10) vide order dtd. 03.07.2004. Relying on the analysis undertaken by the assessee, the enter adjustment on account of contract revenue from AE projects was deleted as the transactions having been analyzed under TNMM were held to be at arm s length. Considering the above facts and circumstances, we direct the Ld.AO to delete the adjustment made by the AO/ TPO. The above grounds of the assessee are, therefore, allowed. Adjustment to transaction related to payment for technical service by determining the arm s length price of such payments as NIL - TPO has applied CUP method - HELD THAT - Deputation of the licensor personal in Article 4 and as such payments made in pursuance of the same are distinct from the royalty consideration as specified in the Article 7 and as such is allowable as deduction. We find that the learned that TPO/DRP has failed to appreciate the fact that the payment of royalty and technical services serve two different purposes. We also find that the TPO has accepted the use of TNNM method in A.Y. 2008-09 as most appropriate method for the purpose of benchmarking the impugned International, whereas the approach proposed by the TPO for the year under appeal is absolute contradiction of the approach adopted earlier in TP order for A.Y. 2008-09. In the succeeding years i.e. A.Y. 2012- 13 and A.Y. 2013-14, the TPO has accepted this factual position by not making any adjustment for amounts paid for services covered under Article 2, Article 3, and Article 4 of the agreement in case of Manideep Unit and Article 4.2 in respect of agreement in the case of Prithla Unit. The additions made in A.Y. 2012-13 amounting pertained to sums, details of which were furnished by the assessee himself, which were covered under Royalty Agreements and that whose ALP was taken at Nil. The learned Counsel for the assessee, has furnished the details of adjustments vide Anx-A for A.Y. 10-11 and Anx-B for A.Y. 11-12, which are wrongly sustained by the DRP in connection with payments for technical services wrongly held to be already covered in Royalty agreement specifying the exact nature of the sum so paid along with the exclusion clauses relating to Royalty agreements to substantiate the claim of the assessee that amounts so adjusted by the TPO /DRP for A.Y. 2010-11 and A.Y. 2011-12. Since the TPO has accepted the fact that above nature of services does not fall under the clause of royalty as per TCA, we are of that view that no adjustment is called for in the case of the assessee. Therefore, the TPO was not justified in making adjustment as the same were on account of payments not covered under the Royalty Agreement. We are of the considered view that the payments made in respect of Mandideep and Prithla Units as sustained by the DRP by holding as covered by royalty agreement are not sustainable in law as the same are not covered under the royalty clause of respective TCA dtd. 01.01.2006 in respect of Mandideep units and dtd. 26.04.2006 in respect of Prithla Unit for aforesaid units. Accordingly the TP adjustments of ₹ 1,17,23,967/- for A.Y. 2010-11 and ₹ 34,18,088/- for A.Y. 2011-12 are directed to be deleted. Denial of relief to the Appellant in relation to international transaction of payment of technical services - HELD THAT - This amount is appearing at Serial No. 11 of the details of payment which relates to payment made for support in respect of business development and not for design and drawing of contract products hence, same is covered by exclusion clause in 3.2 of the agreement relating to general technical assistance by active participation in establishing marketing, design, production, assembly, quality control testing application, installation, commissioning and servicing. Therefore, this amount is not covered by Ro agreement; hence, it is required to be deleted. Hence, this grounds of appeal is allowed. Not allowing set-off of surplus revenue / profit exceeding the arm s length price earned from other transaction while computing the transaction-by- transaction analysis approach - HELD THAT - We are of the view that the decisions rendered in above ground would take care of this ground. However, even if there is any surplus of revenue /profits remains after giving appeal effect to this order, the AO may consider for allowing set-off if admissible under the law. These grounds are disposed-of accordingly. Disallowance of payments made by the assessee to its overseas parent company for the purchase of technical drawings and designs that same in the nature of royalty on which tax was required to be deducted at source - HELD THAT - we are of the considered opinion that the assessee has purchased copyrighted items in form of technical drawings and designs only and the amount paid on account of supply of technical drawings and designs is not in the nature of royalty, hence, no TDS was required to be deducted under section 195 of the Act. Therefore, disallowance made under section 40(a)(ia) of the Act by The AO/TPO and sustained by the DRP is not justified hence, directed to be deleted. Disallowance of warranty provisions - HELD THAT - Making a provision for all known liabilities is a fundamental principle of the mercantile system of accounting and the assessee by provisioning for the liability arising from warranty clauses of the long- term contracts has to abide by such accounting principles. It is seen that the assessee had debited the relevant expenses to the warranty provision account. For this purpose, the assessee has furnished project-wise details of the warranty expenses booked during the year and also explanation regarding the basis of claiming the same as business expenditure. As submitted to the AO that once the warranty period specified under the contract lapses, the surplus balance lying in the warranty provision account is transferred back to the profit and loss account. As concluded that the provision for warranty is in the nature of an ascertained liability (with a reasonable estimate of the quantum) and not a contingent liability , hence, a deduction for the same should be allowed while computing the total income of the assessee for the relevant assessment years. We find that the assessee has made provision for warranty for each project separately taking into consideration all the factors with regard to the scope of work, terms of warranty agreed with the customers and estimated cost of warranty based on earlier years experience. This method of warranty provisions was consistently followed over the years, which is also in accordance with the Accounting Standard under section 145(2). Thus, basis of provision was not an ad-hoc or contingent as alleged by the AO. With regard to the reasonableness of the warranty provision, we had verified from the warranty provision reversed on yearly basis and the same was found to be reasonable. DRP is justified in allowing the deduction on account of warranty provisions. In the result, grounds taken by the Revenue for the A.Ys. 2010-11 and 2011-12 with respect to provision of warranty are dismissed.

Summary

Issues Involved:
1. Transfer Pricing Adjustments
2. Payment for Technical Services
3. Disallowance of Payments for Technical Drawings and Designs
4. Initiation of Penalty Proceedings
5. Short Credit of Tax Deducted at Source (TDS)
6. Disallowance of Warranty Provisions

Detailed Analysis:

1. Transfer Pricing Adjustments:
Issue: Adjustment of ?43,11,705/- (A.Y. 2010-11) & ?17,71,095/- (A.Y. 2011-12) related to “Contract revenue from Projects”.

Facts: The Assessee adopted Cost Plus Method (CPM) for computing the Gross Profit (GP) margin. The TPO compared the GP margin of transactions with Associated Enterprises (AEs) and Non-AEs on a project-by-project basis, rejecting the aggregation approach used by the Assessee.

Decision: The Tribunal found that unrelated party transactions cannot be reliably compared with related party transactions on an individual basis. It was held that the arithmetic mean of gross margins from all related party transactions should be compared with the arithmetic mean of gross margins from all unrelated transactions. The Tribunal directed the AO to delete the adjustment made by the TPO.

2. Payment for Technical Services:
Issue: Adjustment of ?1,17,23,967/- (A.Y. 2010-11) and ?34,18,088/- (A.Y. 2011-12) by determining the arm's length price of such payments as NIL.

Facts: The TPO determined that the payments for technical services were covered under the Technical Collaboration Agreement (TCA) and thus, were duplicative. The DRP partially upheld the TPO's adjustments.

Decision: The Tribunal found that the payments for technical services were not covered by the royalty clause in the TCA. The services under Articles 2, 3, and 4 of the TCA were distinct from those under Article 5, which pertained to manufacturing and selling rights. The Tribunal directed the deletion of the adjustments.

3. Disallowance of Payments for Technical Drawings and Designs:
Issue: Disallowance of ?1,06,99,464/- (A.Y. 2010-11) and ?3,21,61,710/- (A.Y. 2011-12) on the ground that these payments were in the nature of royalty.

Facts: The AO treated the payments for technical drawings and designs as royalty under Article 12 of the DTAA with Austria and disallowed them under section 40(a)(ia) for non-deduction of TDS.

Decision: The Tribunal held that the payments were for the purchase of copyrighted articles (technical drawings and designs) and not for the use of copyrights. The transactions were treated as outright purchases and not as royalty. The Tribunal directed the deletion of the disallowance.

4. Initiation of Penalty Proceedings:
Issue: Initiation of penalty proceedings under section 271(1)(c) of the Act.

Decision: The Tribunal held that no appeal lies against the mere initiation of penalty proceedings and dismissed these grounds as premature.

5. Short Credit of Tax Deducted at Source (TDS):
Issue: Short credit of TDS of ?26,920/- (A.Y. 2010-11) and ?1,81,109/- (A.Y. 2011-12).

Decision: The Tribunal directed the AO to allow due credit of TDS after verification.

6. Disallowance of Warranty Provisions:
Issue: Disallowance of ?3,47,53,202/- (A.Y. 2010-11) and ?3,52,88,923/- (A.Y. 2011-12) on account of provision for warranty expenses.

Facts: The AO disallowed the warranty provisions, treating them as contingent liabilities. The DRP allowed the provisions, holding them as ascertained liabilities.

Decision: The Tribunal upheld the DRP's decision, finding that the warranty provisions were based on a reasonable estimate and were consistently followed over the years. The Tribunal dismissed the Revenue's appeal on this issue.

Conclusion:
The Tribunal allowed the Assessee's appeals on the issues of transfer pricing adjustments, payment for technical services, and disallowance of payments for technical drawings and designs. It dismissed the Revenue's appeals regarding the disallowance of warranty provisions. The Tribunal also directed the AO to allow due credit for TDS and dismissed the grounds related to the initiation of penalty proceedings as premature.