2012 (5) TMI 283 - AT - Income Tax

Transfer pricing - Challenge to the order passed by the Dispute Resolution Panel (DRP) u/s 143(3) read with sec. 144C - Most Appropriate Method (MAM) - Resale Price Method (RPM) or Transaction Net Margin Method (TNMM) - Selection of comparable - held that - assessee has followed the internal CUP method for arriving at ALP for the import of raw material, where as the TPO, in his order, has mentioned that the assessee has adopted the external CUP method. Similarly, for the royalty payment, the assessee has adopted the external cup method and it was a single payment, whereas the TPO observed at page 21 of his order that it is recurring payment. There were many flaws in the TPO s order which demonstrate that the facts of the case have not been properly appreciated by the TPO while making the TP study analysis. - Matter remanded bact. Disallowance of warranty provisions - business of desk tops and lap tops from IBM - held that - Hon ble Supreme Court in the case of Rotork Controls India (P.) Ltd., (2009 (5) TMI 16 (SC)) has held that when a product is sold with a warranty provision, it cannot be held that the assessee has no obligation for the said warranty but for making a provision for the said warranty a reliable estimate should be made on the amount of obligation and a scientific method should be used. - Matter remanded back for reconsideration. Revenue or capital expenditure - marketing support agreement - held that - it is for efficient running of the business and deriving revenues there-from. In such circumstances, we are inclined to hold that the fees paid by the assessee for marketing support services rendered by IBM, is clearly revenue in nature and is allowable as deduction u/s 37 of the Income-tax Act. Taking over the business - discharge of the liability of the predecessor - held that - held by the Hon ble Supreme Court in the case T. Veerabhadra Rao, K. Koteswara Rao & Co. (1985 (7) TMI 2 (SC)), the successor of a business steps into the shoes of its predecessor and is liable to meet any claims against the predecessor. - Decided in favor of assessee.

Issues Involved:
1. Violation of principles of equity and natural justice.
2. Jurisdiction of the JCIT (TP-II) in passing the order.
3. Rejection of Resale Price Method (RPM) and adoption of Transaction Net Margin Method (TNMM).
4. Adjustment related to sale of redundant stock of parts.
5. Benchmarking of software license using TNMM.
6. Data set of comparables for manufacturing segment under TNMM.
7. Rejection of risk adjustment and standard adjustment of 5 percent.
8. Disallowance of warranty provision.
9. Disallowance of R&D cess payable.
10. Disallowance of marketing support fees paid to IBM as capital expenditure.
11. Disallowance of Future Billing Adjustment (FBA) and Duty Free Replenishment Certificate (DFRC) receivable written off.
12. Levy of interest under sections 234B and 234D.

Issue-wise Detailed Analysis:

1. Violation of Principles of Equity and Natural Justice:
The assessee contended that the order passed by the Dispute Resolution Panel (DRP) was contrary to law and made without giving adequate opportunity for being heard. The panel also failed to consider the submissions made by the appellant. This ground highlights the alleged procedural lapses and the violation of natural justice principles.

2. Jurisdiction of JCIT (TP-II):
The assessee initially raised the issue of jurisdiction of the JCIT (TP-II) in passing the order under section 92CA of the Income-tax Act. However, this ground was not pursued further during the hearing and was rejected as not pressed.

3. Rejection of Resale Price Method (RPM) and Adoption of Transaction Net Margin Method (TNMM):
The assessee argued that the DRP erred in upholding the rejection of RPM for the import of parts for manufacturing and instead adopting TNMM. The TPO had considered the resale of parts initially imported for manufacturing as a separate trading activity. The tribunal found that the TPO did not properly appreciate the facts and methods adopted by the assessee. It noted inconsistencies in the TPO's approach, particularly when similar transactions were accepted in subsequent years without adjustments. The matter was remitted back to the assessing authority to verify the consistency in the approach for the relevant assessment year.

4. Adjustment Related to Sale of Redundant Stock of Parts:
The assessee contended that the sale of redundant stock of parts was closely linked to manufacturing operations and should not be treated as a separate trading activity. The tribunal agreed with the assessee's contention, emphasizing the need for continuity and uniformity in the revenue's approach across different assessment years.

5. Benchmarking of Software License Using TNMM:
The assessee argued against the use of TNMM for benchmarking the software license, stating that it merely reimbursed the cost of software procured by the associated enterprise from third parties. The tribunal found that the TPO had not properly considered the facts and methods adopted by the assessee. The issue was remitted back to the assessing authority for reconsideration.

6. Data Set of Comparables for Manufacturing Segment Under TNMM:
The assessee challenged the data set of comparables used for benchmarking the manufacturing segment under TNMM. The tribunal noted flaws in the TPO's order and remitted the issue back to the assessing authority for verification and consistency with subsequent years' assessments.

7. Rejection of Risk Adjustment and Standard Adjustment of 5 Percent:
The assessee contended that the DRP erred in rejecting the claim for risk adjustment and the standard adjustment of 5 percent from the arithmetic mean margin computed for benchmarking under TNMM. The tribunal found that the TPO did not properly appreciate the facts and methods adopted by the assessee. The issue was remitted back to the assessing authority for reconsideration.

8. Disallowance of Warranty Provision:
The assessee had provided for warranty expenses based on a scientific method, using past data from IBM. The assessing officer disallowed the provision, considering it unascertained. The tribunal referred to the Supreme Court's decision in Rotork Controls India (P.) Ltd., which allows for such provisions if made on a reliable estimate. The issue was remitted back to the assessing authority to verify the scientific basis of the provision.

9. Disallowance of R&D Cess Payable:
The assessee did not pursue this ground further during the hearing, and it was rejected as not pressed.

10. Disallowance of Marketing Support Fees Paid to IBM as Capital Expenditure:
The assessee argued that the marketing support fees paid to IBM were for smooth and efficient business operations and should be treated as revenue expenditure. The tribunal agreed, noting that the services rendered by IBM were for the efficient running of the business and not for acquiring any capital asset. The fees were allowed as a deduction under section 37 of the Income-tax Act.

11. Disallowance of Future Billing Adjustment (FBA) and Duty Free Replenishment Certificate (DFRC) Receivable Written Off:
The assessee contended that the FBA and DFRC receivables written off were necessary for carrying on its business and should be allowed as revenue expenditure. The tribunal agreed, noting that the assessee had taken over liabilities from IBM and incurred these expenses to maintain business relations and for smooth operations. The write-off of DFRC was also justified due to changes in customs duty regulations. The expenses were allowed as revenue expenditure.

12. Levy of Interest Under Sections 234B and 234D:
This ground was found to be consequential in nature, and the assessing officer was directed to give consequential relief to the assessee if any.

Conclusion:
The appeal filed by the assessee was partly allowed, with several issues remitted back to the assessing authority for reconsideration and verification, and specific deductions allowed as revenue expenditure.

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