2018 (2) TMI 2020 - AT - Income Tax

Disallowance of provision for warranty - whether there is an obligating event for creating the provisions whether there is any outflow of resources to settle the obligations and whether any reliable estimate was made to quantify the obligations - HELD THAT - n the instant case it is evident from the aforesaid table that in earlier years no provision of warranty was created. It was created for the first time in the assessment year 2009-10 but there was no utilization nor reversal in that year. In subsequent year i.e. 2010-11 further provision was created but there was no utilization and only reversal of earlier provisions was done. Similarly in the assessment year 2011-12 no further provision was made and no utilization was done. Only reversal of the earlier provision was done. In the light of details available we find that there was no obligating events which requires the provisions for liability. Moreover there is no outflow of the resources required to settle the obligation. In the absence of the obligating event and the outflow of resources required to settle the obligations we are of the view that estimate of provisions made by the assessee is not on scientific basis and also not reliable. It is also important to note that from assessment year 2011-12 assessee stopped creating provision of warranty. Under these circumstances we are of the view that in the absence of any claim of warranty in earlier year provisions of warranty was not required at all. Therefore it cannot be allowed. We accordingly find force in the observations of the AO though he was required to allow the claim on account of directions of DRP. Therefore we reverse his findings and direct the AO to disallow the claim of provisions of warranty. TP Adjustment - MAM selection - TNMM or RPM - HELD THAT -Undisputedly assessee is a distributor of AO Smith China which is involved in the manufacture of water heaters and sells the water heater imported from AO Smith China in India without making any value addition to the product in a similar type of case it has been repeatedly held by the Tribunal and the Hon ble High Court of Bombay that in case of distributor whether the product is being sold to the uncontrolled entities without making any value addition RPM is the most appropriate method and should be preferred over TNMM. Accordingly we set aside the order of the AO passed consequent to the direction of the DRP in this regard and direct the AO/TPO to adopt the RPM as the most appropriate method.

Summary

Issues Involved:

1. Disallowance of provisions for warranty.
2. Determination of the most appropriate method for computing the Arm's Length Price (ALP) of international transactions.

Detailed Analysis:

1. Disallowance of Provisions for Warranty:

The primary issue raised by the Revenue was the disallowance of the provision for warranty amounting to ?41,69,288/-. The Revenue contended that the provision was made without any basis and was reversed in subsequent years without actual utilization. The Revenue relied on the Supreme Court's judgment in the case of Rotork Controls India (P.) Ltd., which mandates that provisions must be made based on scientific principles and past experiences.

The Tribunal examined the facts and found that the assessee had not utilized any amount from the warranty provision in the relevant and subsequent years. The Tribunal noted that the provision should be based on past events and a reliable estimate of future obligations. Since the assessee had not shown any actual utilization or scientific basis for the provision, the Tribunal concluded that the provision was not made in a scientific manner and did not meet the conditions laid down by the Supreme Court. Therefore, the Tribunal directed the Assessing Officer (AO) to disallow the claim of provisions for warranty.

2. Determination of the Most Appropriate Method for Computing the ALP of International Transactions:

The second issue involved the determination of the most appropriate method for computing the ALP of the international transactions between the assessee and its associated enterprises (AEs). The assessee, a trading company distributing water heaters imported from its AE, had adopted the Resale Price Method (RPM) for benchmarking the transactions. The Transfer Pricing Officer (TPO) rejected the RPM and adopted the Transactional Net Margin Method (TNMM) instead.

The Tribunal referred to various judicial pronouncements and noted that in cases where a distributor purchases goods from its AE and resells them without any value addition, the RPM is generally considered the most appropriate method. The Tribunal cited cases such as Horiba India (P.) Ltd., Bose Corporation (P.) Ltd., and L'Oreal India (P.) Ltd., where the RPM was preferred over the TNMM for distributors.

The Tribunal found that the assessee was a distributor selling water heaters without any value addition and that the RPM was the most appropriate method for determining the ALP. The Tribunal set aside the order of the AO and directed the AO/TPO to adopt the RPM as the most appropriate method.

Conclusion:

The Tribunal allowed the appeal of the Revenue by disallowing the provision for warranty and allowed the appeal of the assessee by directing the AO/TPO to adopt the RPM as the most appropriate method for computing the ALP of the international transactions.