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TMI Blog2008 (9) TMI 420X X X X Extracts X X X X X X X X Extracts X X X X ..... er to exclude the said provision while computing the book profit under section 115JB. 3. In its profit and loss account, warranty charges amounting to Rs. 4,04,12,572 were debited by the taxpayer company. The said amount was inclusive of the warranty expenses actually incurred by the taxpayer company to the extent of Rs. 1,78,73,650 and the remaining amount of Rs. 2,25,38,920 was on account of provision made for anticipated warranty expenses in respect of the remaining part of the warranty period. According to the Assessing Officer, the amount that may be payable by the taxpayer company on account of possible claims of warranty arising in the future constituted its contingent liability and the provision made for such contingent liability was not deductible while computing its total income. He, therefore, disallowed the same while computing the total income of the taxpayer under the normal provisions of the Act and also added the same while computing its book profit under section 115JB. The matter was carried before the ld. CIT(A) and it was submitted on behalf of the taxpayer company before him that the provision for anticipated liability on account of warranty claim for unexpired ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , has made an attempt to point out from page 4 of the impugned order of the learned CIT(A) that the provision for warranty made by the taxpayer company at the rate of 2 per cent of the total turnover was highly excessive taking into consideration its own past history wherein such provision was required to be made at only 0.72 per cent. However, as clarified by the learned counsel for the taxpayer, the provision of 2 per cent as referred to by the learned CIT(A) in his impugned order was in the context of a case of Voltas Ltd. decided by Mumbai Bench of ITAT whereas the provision made for warranty by the taxpayer in the present case was only to the extent of 0.75 per cent. We, therefore, hold that the decision of Hon'ble Punjab and Haryana High Court in the case of Majestic Auto Ltd. on a similar issue is squarely applicable in the present case and respectfully following the same, we uphold the impugned order of the learned CIT(A) allowing the deduction claimed by the taxpayer on account for provision for warranty holding the same to be an ascertained liability. Similarly, we also uphold his impugned order deleting the addition made by the Assessing Officer of the said amount wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... support of this contention was placed on behalf of the taxpayer company on the decision of Hon'ble Bombay High Court in the case of CIT v. Bangalore Clothing Co. [2003] 127 Taxman 637. In the said decision, it was held by the Hon'ble Bombay High Court in this context that if any receipt forms part of the operational income of the taxpayer having regard to its dominant business, the same would be entitled to be included in the profits of the business for the purpose of computing deduction under section 80HHC. According to the ld. CIT(A), all the receipts i.e., sale of scrap, amounts written back and sale proceeds of spare parts included in the miscellaneous income of the taxpayer company were directly related to its dominant business. He, therefore, held that the same forming part of its operational income was liable to be included in the "profits of the business" for the purpose of computing deduction under section 80HHC. 8. After considering the rival submissions and perusing the relevant material on record, we find no infirmity in the impugned order of the learned CIT(A) holding that the miscellaneous income of the taxpayer was eligible for inclusion in the profits of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ator). Before the ld. CIT(A), it was submitted on behalf of the taxpayer that the foreign exchange gain has a very close nexus with the export activity of the company. Relying inter alia on the decision of Delhi Bench of ITAT in the case of Smt. Sujata Grover v. Dy. CIT [2002] 74 TTJ 347, it was contended that the same thus was rightly claimed as part of the eligible profits. After considering the submissions made on behalf of the taxpayer, it was held by the ld. CIT(A) that forex gain relating to the export proceeds was the direct result of the export sales and taking into consideration this close nexus between the two, it was not possible to exclude such gain from the export turnover. He, therefore, directed the Assessing Officer to include the said gain even in the figure of export turnover (numerator) for the purpose of computing exemption under section 10A/10B. 11. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue has also been raised by the taxpayer in ground No. 4 of its appeal being ITA No. 1189/Delhi/2005. At the time of hearing before us, the learned counsel for the taxpayer, however, has not pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1989] 177 ITR 377 and Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 as well as Tribunal's decision in the case of Media Video Ltd. v. Jt. CIT [2002] 122 Taxman 28 (Delhi) (Mag.), it was contended on behalf of the taxpayer that as a result of acquisition of the said software, only an operational or commercial advantage was obtained which being in the revenue field, the expenditure incurred on such acquisition was a revenue expenditure. 16. The details of software expenses claimed by the taxpayer were examined by the ld. CIT(A) and on such examination, he found that the same were incurred for acquiring the following softwares:- "(i) Software for TDS calculation, which needs to be revised each year based on changes in Budget Notifications; (ii) E-CRM networking/Internet gateway for B2B, which requires to be updated periodically based on changes in Marketing requirement, change in product line, new launches etc.; (iii) License fees etc., payable for usage of certain application software and which have no reuse or sale value; (iv) Design and Development/Consultancy charges for Software development which do not have reuse/sale value. (v) Payment of SAP Service module is rel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, he submitted that the said decision supports the case of the taxpayer. He contended that as held by the Special Bench of the Tribunal in the said case, where the advantage consists merely in facilitating taxpayer's trading operations or enabling conduct of taxpayer's business more efficiently or more profitably, the expenditure would be on revenue account. He submitted that the details of the software expenditure incurred by the taxpayer in the present case as given in Annexure-4 would make it clear that the said expenditure was incurred for improving the day-to-day efficiency and for carrying out the business of the taxpayer company in a more efficient manner. He contended that the said expenditure thus was incurred on revenue account as held by the Special Bench of the Tribunal in the case of Amway India Enterprises and the softwares acquired by the taxpayer company being mere facilitators, the expenditure incurred thereon was rightly held by the learned CIT(A) as of revenue in nature. 20. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that a similar issue has been considered and decided by Delhi Special ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reover, the benefit of the decision of Special Bench in the case of Amway India Enterprises was not available to the authorities below when this issue came to be decided by them and it would be in the interest of justice to give them an opportunity to re-examine the same in the light of criteria/guidelines laid down by the Special Bench. Accordingly, we set aside the impugned order of the learned CIT(A) on this issue and restore the matter to the file of the Assessing Officer for deciding the same afresh as per the guidelines laid down by the Special Bench of ITAT in the case of Amway India Enterprises. Ground No. 5 of the revenue's appeal is accordingly treated as allowed for statistical purposes. 22. The next issue raised in ground No. 6 of the revenue's appeal relates to the taxpayer's claim on account of loss due to fluctuation in foreign exchange rate. 23. While finalizing its books of account, the foreign currency transactions were reinstated by the taxpayer company at the exchange rate prevailing on the balance sheet date and the resulting loss on account of foreign exchange fluctuation on such reinstatement of current assets or liabilities amounting to Rs. 31, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oration, Japan. He, therefore, disallowed the said expenditure to the extent of 10 per cent on estimated basis treating that the same was attributable to the benefit flown to the parent company. The learned CIT(A), however, deleted the disallowance made by the Assessing Officer on this issue holding that as the expenditure on advertisement and sales promotion was incurred by the taxpayer company wholly within India, no benefit had accrued to its parent company in Japan. In addition to the disallowance of 10 per cent made out of advertisement and sales promotion expense on the ground that the same was attributable to the brand promotion resulting in benefit to the parent company in Japan, a further disallowance of 10 per cent was made by the Assessing Officer out of advertisement and sales promotion expenses treating the same to be of capital nature on the ground that advantage of enduring nature had accrued to the taxpayer company. The learned CIT(A), however, deleted the said disallowance observing that as the memory of the customers is short and advertisement is required to be done on year to year basis, the expenditure incurred on advertisement and sales promotion could not be s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was duly reduced from the total advertisement expenditure and only net amount was claimed as deduction. He placed reliance on the decision of Delhi Bench of ITAT in the case of Nestle India Ltd. v. Dy. CIT [2007] 111 TTJ 498 stating that a similar issue involved in the said case has been decided by the Tribunal in taxpayer's favour. He also placed reliance on the decision of Mumbai Bench of ITAT in the case of Star India (P.) Ltd. v. Addl. CIT [2006] 103 ITD 73 (TM). As regards the disallowance of 10 per cent made by the Assessing Officer out of advertisement and sales promotion expenses treating the same as of capital nature, the learned counsel for the taxpayer submitted that since the expenditure on advertisement and sales promotion is required to be incurred every year, there was no benefit of enduring nature derived by the taxpayer company by incurring the said expenditure. He also submitted that the said expenditure in any case was made by the taxpayer company on revenue account and the same, therefore, could not be treated as capital expenditure even if the test of enduring benefit is assumed to be satisfied. In support of this contention, he relied on the decision of Ho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... td. wherein it was held that advertisement expenses incurred on promoting viewership on TV channel by the taxpayer engaged in procuring programs for those channel were expenditure incurred wholly and exclusively for the purpose of its business and it could not be disallowed on the ground that it might have also benefited the taxpayer's principal. To the similar effect is the decision of Delhi Bench of ITAT in the case of Nestle India Ltd. cited by the learned counsel for the taxpayer wherein it was held that advertisement and sales promotion expenses incurred by the taxpayer for promoting sales in India in respect of products manufactured by it under various brands of a foreign company were allowable in entirety even though it might have benefited the non-resident company who owned the said brands. Keeping in view both these decisions of the Tribunal and taking into consideration the facts of the case as discussed above, we hold that the disallowance of 10 per cent made by the Assessing Officer out of advertisement and sales promotion expenses on the ground that the same resulted in the benefit to the parent company was not sustainable and the learned CIT(A) was fully justified ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pitalizing the loss as a result of foreign exchange fluctuation thus was not allowable. The learned CIT(A), however, allowed the said claim of the taxpayer for depreciation relying on the pre-amended provisions of section 43A as applicable to the year under consideration. 33. At the time of hearing before us, the learned representatives of both the sides have agreed that this issue is squarely covered in favour of the taxpayer by the judgment of Hon'ble Delhi High Court in the case of Woodward Governor India (P.) Ltd. wherein it was held that in a case where a taxpayer has acquired any capital asset from abroad for the purpose of his business or profession on credit or on deferred payment terms or against a loan in foreign currency and the whole or part of the cost of such asset or of the loan in foreign currency is outstanding as on the date on which there was a change in the rate of exchange of currency, the original actual cost to the taxpayer of such asset is required to be increased or as the case may be reduced correspondingly, inter alia, for the purposes of depreciation. It was also held that the amendment made to section 43A with effect from 1-4-2003 was prospective a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 34D. 38. In the assessment order, interest under section 234D was levied by the Assessing Officer on the amount of excess refund granted to the taxpayer company while processing its return of income originally under section 143(1). The learned CIT(A), however, noted that the provisions of section 234D have been introduced in the statute by the Finance Act, 2003 with effect from 1-6-2003. According to him, the said provisions thus were applicable only in relation to assessment year 2003-04 onwards and interest under that provision could not be levied in the taxpayer's case involving assessment year 2001-02. 39. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue is squarely covered in favour of the taxpayer by the recent decision of Delhi Special Bench of ITAT in the case of ITO v. Ekta Promoters (P.) Ltd. [2008] 113 ITD 719 wherein it has been held that interest under section 234D is chargeable from assessment year 2004-05 and the same could not be charged for earlier years. Since the assessment year involved in the present appeal is 200102, we uphold the impugned order of the learned CIT(A) cancelling ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ellaneous income originates in the process of carrying on the core business activity of the undertaking. He submitted that similarly 'Service Income' was mainly comprising of income received by the taxpayer company from repairs of goods sold to the customers. He submitted that since the goods sold by the taxpayer were consumer electronic goods, it was pertinent for the appellant to provide appropriate 'after sales services and support' beyond the warranty period to ensure that consumers of goods receive good value for their money and quality service. He contended that servicing of these components thus constituted an essential ingredient of the business activity of the taxpayer company and was inextricably linked to the goods being sold by it. 45. As regards the advisory service income received from Sony Corporation of Hong Kong Ltd. in pursuance of an advisory service agreement, he submitted that for carrying out its manufacture and sales operations in the Indian market, the taxpayer company needs to constantly update its knowledge of various technological advancements, customer perceptions and changes in the demand pattern in the Indian market. As a result, it ga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itted that for this conclusion, the Tribunal relied, inter alia, on the judgments of Hon'ble Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84, CIT v. Sterling Foods [1999] 237 ITR 579 and Pandian Chemicals Ltd. v. CIT [2003] 262 ITR 278 wherein the scope and ambit of the expression "derived from" as used in section 80-IA was explained by the Hon'ble Apex Court. 48. We have considered the rival submissions and also perused the relevant material on record. It is observed that a similar issue relating to eligibility of service income and miscellaneous income earned by the taxpayer for deduction under section 80-IA had arisen for consideration before the Tribunal in taxpayer's own case for assessment year 2000-01 and vide its order dated 31-8-2004, the Tribunal decided the same against the taxpayer for the following reasons given in paragraph No. 23 of the said order:- "23.The next question for our consideration is as to whether the receipts from activity of services and the miscellaneous incomes can be considered to be profits derived from industrial undertaking of the taxpayer. We find that the legal position in this rega ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he sale of electronic goods and the other receipts cannot be construed to be directly connected with the impugned activity of the eligible industrial undertaking. We do not dispute the fact that such receipts would, on parameters of being incidental to business, can fall within the business of the taxpayer, yet cannot be said to be derived from the eligible industrial undertaking of the taxpayer. Therefore, on this count, we sustain the stand of the taxpayer only to the extent mentioned herein above. Before we part, we may discuss the alternative plea of the appellant that in order to exclude the aforesaid incomes from profits eligible for deduction under section 80-IA, what was required to be excluded was the net income of such activity and not the gross receipts from such activities. We do not find any infirmity in the aforesaid pleas of the taxpayer. For this limited purpose, we remit the issue to the file of the Assessing Officer to re-work the deduction allowable to the taxpayer under section 80-IA on the basis of the aforesaid discussion. The second ground is accordingly disposed of." 49. Before us, the learned counsel for the taxpayer has submitted that the decision of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trial undertaking must be there and if such nexus is not direct but only incidental, the same could not be said to be the "profits derived from an industrial undertaking". In the case of Pandian Chemicals Ltd., Hon'ble Supreme Court reiterated this position by holding that in order to fall within the expression "profits derived from an industrial undertaking", the immediate source of earning such income should be the industrial undertaking itself. In the present case, the business of the eligible industrial undertaking of the taxpayer company is to manufacture and sale of electronic goods and keeping in view the nature of this main business, we are of the view that the miscellaneous income and service income earned by the taxpayer could not be said to have been derived from such business by the said industrial undertaking for the purpose of allowing deduction under section 80-IA. As regards the reliance of the learned counsel for the taxpayer on the decision of Hon'ble Bombay High Court in the case of Bangalore Clothing Co., it is observed that the same was rendered in the context of computation of profits of the business for the purpose of computing deduction under section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the same, therefore, was not eligible for deduction under section 80HHC. Accordingly, he excluded the said income from the profits of the business for the purpose of computing deduction under section 80HHC. The matter was carried before the learned CIT(A) who examined the nature of service income and found on such examination that the said income did not form part of the main business activity of the taxpayer company. He, therefore, upheld the action of the Assessing Officer in excluding the service income from the profits for the purpose of computing deduction under section 80HHC. 52. The learned counsel for the taxpayer, at the outset, submitted that service income constituted a part of business income of the taxpayer company which is evident from the fact that in its return of income, the said income was offered to tax under the head "Profits and gains of business or profession". He submitted that this treatment given by the taxpayer company was accepted by the Assessing Officer himself while completing the assessment and he, therefore, was not justified in excluding the said income from profits of the business for the purpose of computing deduction under section 80HHC. Referr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such as rent, brokerage etc. so as to exclude it from the profits of the business for the purpose of computing deduction under section 80HHC. According to him, the said income in fact clearly constitutes operational income of the taxpayer company having regard to its nexus with the main activity of business and the same, therefore, was liable to be included in the profits of the business as held by Hon'ble Bombay High Court in the case of Bangalore Clothing Co. 54. The learned DR, on the other hand, submitted that the service income in question was earned by the taxpayer company for the services rendered to its sister concern abroad and keeping in view the nature of such services rendered by it relating to marketing, it cannot be said that it has got any link either direct or even indirect with the main business operations of the taxpayer company. She contended that the said income, therefore, cannot constitute the operational income of the taxpayer as explained by the Hon'ble Bombay High Court in the case of Bangalore Clothing Co. and the same was liable to be excluded from the profits of the business for the purpose of computing deduction under section 80HHC as rightly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n activity of the taxpayer company, it cannot be said that the service income accrued to it as a part of the main business activity. At the most, the said activity could be treated as incidental business activity of the taxpayer company and the income earned therefrom could be said to be accrued to it out of such incidental business. This view gets support from the decision of Hon'ble Bombay High Court in the case of CIT v. K.K. Doshi & Co. [2000] 245 ITR 849 wherein the taxpayer firm was in the business of export of polished diamonds out of India. During the relevant year, it undertook work of polishing diamonds on job work/contract basis for third parties in India and the income earned from the said activity in the form of service charges was claimed to be includible in the profits of the business for the purpose of computing deduction under section 80HHC. This claim of the taxpayer, however, was held to be not allowable by the Hon'ble Bombay High Court observing that the activity of polishing undertaken by the taxpayer firm on job work/contract basis having no nexus with its main export activities, the service charges could not be considered as part of the business profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxpayer by the decision of the Tribunal in taxpayer's own case for assessment year 2000-01 rendered vide its order dated 31-8-2004 in ITA No. 4790/Delhi/2003. Respectfully following the said decision of the Tribunal in the aforesaid case, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 2 of the revenue's appeal. 59. As regards ground No. 3 relating to deduction under section 80HHC in respect of miscellaneous income i.e., sale of scrap, accounts written back etc., it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 3 of the revenue's appeal. 60. As regards ground No. 4 of the revenue's appeal relating to exclusion of excise duty from turnover for deduction under section 80HHC, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 2 of the revenue's a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 7 of the revenue's appeal. 65. Ground No. 9 raised by the revenue in its appeal for assessment year 2002-03 relates to the transfer pricing issue which is being considered separately along with the relevant grounds raised by the taxpayer relating to the same issue while disposing of the appeal of the taxpayer. ITA No. 819/Delhi/2007-Taxpayers appeal for A.Y. 2002-03 66. Ground No. 1 raised by the taxpayer in this appeal is general seeking no specific adjudication from us. 67. Ground No. 2 relates to the disallowance of taxpayer's claim for deduction under section 10A/10B in respect of miscellaneous Income. 68. The taxpayer company is running two software development centres at Bangalore viz., S.I.S.C. and S.A.R.D. for development of product related and application software. SISC and SARD were eligible for deduction under sections 10A and 10B respectively during the year under consideration. While computing the said deductions, the taxpayer compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... out that Article-6 of the said agreement explicitly provided for the terms of cancellation of contract and related compensation that shall be awarded upon such termination. He contended that since the said agreement was in relation to development of software which is the core business activity of the undertaking, compensation received on breach thereof forms an integral part of the undertaking making it eligible for deduction under section 10A/10B. He also contended that the entire miscellaneous income in any case originated from the prime business activity of the taxpayer company and the same, therefore, was the income derived from the said activity which is eligible for the said deduction. He submitted that the theory of income derived adopted by the Assessing Officer as well as by the learned CIT(A) relying on the various judicial pronouncements rendered in the context of various provisions of Chapter VI-A cannot be applied in the present case as the issue involved is relating to the exemption provisions of section 10A/10B falling under Chapter III which is separate and distinct from Chapter VI-A. 70. The learned DR, on the other hand, submitted that only the income derived fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... immediate source in the industrial undertaking can enjoy the exemption and not those profits whose immediate source is not the industrial undertaking but something removed therefrom. Keeping in view this ratio of the decision of the Tribunal in the case of Jubiliant Enpro Ltd., we find that the notice pay received by the taxpayer company from its employees cannot be said to have its immediate source in the industrial undertaking so as to make it eligible for deduction under section 10A as claimed by the taxpayer. Moreover, the notice pay received by the taxpayer company from its employees is not certainly reimbursement of the salary expenses incurred by the taxpayer company and the same, therefore, cannot be adjusted against such expenditure as sought to be contended by the learned counsel for the taxpayer. We, therefore, hold that the notice pay received by the taxpayer company from its employees was not eligible for deduction under section 10A as rightly held by the Assessing Officer and the learned CIT(A) was fully justified in upholding the action of the Assessing Officer on this issue. The impugned order of the learned CIT(A) on this issue is accordingly upheld. 72. As regard ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under that section was rightly claimed by it in respect of the said income. In that view of the matter, we set aside the impugned order of the learned CIT(A) on this issue and direct the Assessing Officer to allow the deduction under section 10A/10B in respect of compensation amounting to Rs. 83,06,011 as claimed by the taxpayer company. Ground No. 2 of the taxpayer's appeal is thus partly allowed. 73. As regards ground No. 3 of the taxpayer's appeal relating to its claim for deduction under section 80-IA in respect of miscellaneous income and service income which stands disallowed by the Assessing Officer as well as by the learned CIT(A), it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1189/Delhi/2005. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) and direct the Assessing Officer to allow the claim of the taxpayer on this issue and allow ground No.3 of the taxpayer's appeal. 74. As regards the issue raised by the taxpayer in ground No. 4 relating to its claim fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DR left this issue to the Tribunal to be decided in accordance with law. 78. After considering the rival submissions and perusing the relevant material on record, it is observed that the expenditure of Rs. 6,81,551 claimed by the taxpayer company in assessment year 2003-04 on account of retrospective price revision made by its supplier was categorized by the auditors as "prior period expenses" being pertained to assessment year 2002-03 and relying on the said comment of the auditors, the claim of the taxpayer for deduction on account of the said expenditure was disallowed by the Assessing Officer. Thus, a definite stand was taken by the Assessing Officer relying on the auditors' comment that the said expenditure was actually pertaining to assessment year 2002-03 and this being so, we are of the view that the deduction claimed by the taxpayer for the said expenditure in assessment year 2002-03 should have been allowed by the Assessing Officer. As rightly contended by the learned counsel for the taxpayer before us, there was no justification in disallowing the said deduction in both the years i.e., assessment years 2002-03 and 2003-04 as done by the Assessing Officer. We, there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred on training of employees in these cases to achieve efficient running of business was held to be revenue in nature. He also submitted that the decision of Hon'ble Supreme Court in the case of Madras Industrial Investment Corpn. Ltd. relied upon by the revenue is clearly distinguishable on facts as the issue involved therein was relating to the allowability of discount on issue of debentures which was held to be liable for spreading over the life of debentures. 82. The learned DR submitted that the substantial expenditure incurred by the taxpayer company for imparting training to its employees had definitely given a benefit of enduring nature to it and since the disallowance made by the Assessing Officer out of the said expenditure to the extent of 50 per cent assuming that such benefit had accrued for a period of two years only was quite fair and reasonable, the learned CIT(A) was fully justified in confirming the same. 83. We have considered the rival submissions and also perused the relevant material on record. It is by now well-settled that if the expenditure incurred by the taxpayer is of revenue nature, the same is entirely deductible even if there accrues an advanta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the Hon'ble Supreme Court that the expenditure incurred was of revenue nature as the advantage secured was in the field of revenue and not capital. In the present case, the expenditure incurred by the taxpayer company on imparting training to its employees in order to increase their efficiency in day-to-day working was in the revenue field and this being so and keeping in view the legal position emanating from the judicial pronouncements discussed above, we hold that the same was entirely deductible in the year under consideration as rightly claimed by the taxpayer. The impugned order of the learned CIT(A) confirming the disallowance made by the Assessing Officer to the extent of 50 per cent on this issue is, therefore, reversed and the Assessing Officer is directed to allow the said expenditure in full. Transfer Pricing Issue involved in assessment year 2002-03 84. Ground Nos. 7 to 11 raised in the taxpayer's appeal and ground No. 9 raised in the revenue's appeal involve issues relating to transfer pricing and pertain to the addition made by way of "adjustments" under section 92CA of the Act by determining higher arm's length price than disclosed by the taxpaye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r defective CRTs and rebate received 0.71 9. Services received for IT, communication and sharing of best practices 1.14 86.1 The taxpayer had imported electronic components and CRTs from its associated concerns and had claimed that above items were acquired at Arm's Length Price and for that purpose had relied upon Transactional Net Margin Method (TNMM). It had chosen the foreign AEs from whom the components were imported as tested parties and had computed the profit of AEs with comparable chosen from Indian and other data bases. The same method was chosen for the distribution activities relating to high-end electronic products, projector tapes etc. where the taxpayer was taken as a tested party. Operating profit margin on sales had been chosen as the Profit Level Indicator (PLI). Likewise, TNMM analysis were also employed to justify fees received for advisory services to Sony Singapore and profit earned by the taxpayer. All International Transactions (IT) were claimed at arm's length. The Assessing Officer referred question of determination of arm's length price to the Transfer Pricing Officer (TPO). 87. On consideration of facts and circumstances of the case, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... departure and to sort out the void created by this rejection rests on the taxpayer which has not been discharged." In the long arguments as also in oral submissions, Shri Bhutani, the ld. representative of the taxpayer, did not challenge above action of the TPO. Further, no reference was made before the Tribunal to any consolidated figures. Accordingly, we do not deem it necessary to carry further discussion on this point. Most Appropriate Method 87.2 The TPO agreed that TNMM was the Most Appropriate Method in the circumstances as it is more tolerant to functional differences and accounting differences at gross level gets eliminated due to a comparison at net level while selection of comparables. The TPO further observed that no internal TNMM was possible and, therefore, external independent enterprises engaged in similar functions were identified. Such process was carried out through screening of Prowess Database. For selection of comparable companies engaged in similar functions, following filters were applied:- Steps Nature of the filter applied Reasons Filter 1 To filter those companies that are in the manufacturing industry To identify the larger set of compara ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing and, therefore, not fit to be taken as comparable companies. Godrej Appliances Ltd. was showing persistently heavy losses and was, therefore, not accepted as comparable by the TPO. Accordingly, the operating margin was worked by the Assessing Officer at 9.01 per cent as under:- Name of the company Operating Profit Margin o Sales (OP/Sales) Weighted Average Mean for the years 99-2000 and 2000-2001 BS Refrigerators Ltd. 4.47% Videocon Appliances Limited 14.06% Videocon Communication Ltd. 4.06% Videocon International Ltd. 9.42% Arithmetic Mean 9.01% 90. The taxpayer for working out its operative margin claimed deduction and benefit for not having any tangible property or R&D unit before TPO. It was urged that taxpayer was not bearing risks and was getting no return on account of non-availability of intangibles and research and development activities like the comparables taken into consideration. The TPO accepted above argument and thought it reasonable to allow deduction of 20 per cent out of mean margin of profit of comparables. Therefore, instead of 9.01 per cent calculated as above, he took 80 per cent thereof i.e., 7.2 per cent as operating average profit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of 3.93 per cent from trading. However, after adjustment, the profit margin from trading operation was computed by TPO at - 1.64 per cent which was obviously below the Arm's Length margin of 3.93 per cent. The TPO was, therefore, of the view that adjustment on account of purchases of items was to be made by applying margin of 5.57 per cent (3.93 + 1.64) which he applied to Rs. 116,75,77,000. Thus, total value of international transactions was taken at Rs. 52,24,36,416 against Rs. 58,74,70,454 shown in books and an adjustment of Rs. 65,034,038 was directed to be made as per calculation below:- "Amount of adjustment = 5.57% of Rs. 1,167,577,000 = Rs. 65,034,038 Total value of international transactions pertaining = Rs. 587,470,454 to import of finished goods Arm's Length price = Rs. 587,470,454 - Rs. 65,034,038 = Rs. 522,436,416 Difference in per cent terms between ALP and International Transactions = 12.44% 12.1.1 Proviso to section 92C(2) permits a maximum variance of 5 per cent from the Arm's Length Price. In this case the difference of 12.44 per cent being more than 5 per cent is not acceptable. Hence it is concluded that the price adopted by the taxpayer h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssociated Enterprise (AE) Transaction Amount (in Rs.) Arm's Length Price (79.59% of Transaction Amount) Sony Electronics (Singapore) Pte. Ltd. ("SES") 512,172,310/- 407,637,942 Sony Electronics (Singapore) Pte. Ltd. - Sony Display Device Division ("SDD") 604,101,283/- 480,804,211 Sony Electronics (Malaysia) SDN BHD, ("SEM") 826,893/- 658,124 Sony Corporation, Tokyo ("SC") - Sony Trading International Corporation ("STIC") 190,604,872/- 151,702,418 Sony Technology Malaysia SDN BHD ("STM") 353,511,552/- 281,359,844 Shanghai Suoguang Visual Products Co. Ltd. ("SSV") 38,519,161/- 30,657,400 Total 1,699,736.071/- 1,352,655,163 12.2.2 The Assessing Officer shall, therefore, make an addition of Rs. 347,080,908 to the total income of the Taxpayer." 91. The TPO also found that the taxpayer had exported 8680 units of 21 inches Television for Rs. 9,964.65 each to Sony Japan. The TPO found that sale price of TV sold to independent distributors in India was ranging between Rs. 20,000 to Rs. 17,000 as detailed in para 12.3 of its order. The TPO rejected taxpayer's submissions that these TV s were manufactured in unutilized idle capacity of the taxpayer and were s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... written submissions by the ld. Authorized Representative of the taxpayer. Therefore, we do not deem it necessary to refer to the finding recorded by the learned CIT (Appeals) on above issues. 93.1 The learned CIT (Appeals) held that for purposes of transfer pricing evaluation, each and every transaction should be taken as a distinct and separate transaction. Profit of each segment should be separately worked out through an accepted method of evaluation. In support of above finding the learned CIT (Appeals) relied upon para 1.42 of OECD Guidelines. It was accordingly held that stand taken by TPO in treating assembly and distribution as separate business segment was correct. The learned CIT (Appeals) also quoted from taxpayer's reply dated 18-3-2005 to show that segmented figures of margin of profit were furnished by the taxpayer. It was held that taxpayer was now changing its stand. 93.2 On the objection of the taxpayer that the selection of the comparables and screening process adopted by the TPO was flawed, the learned CIT (Appeals) noted various criteria adopted by the TPO for the purposes of screening and carrying search on prowess to identify and select comparables. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uncontrolled environment would normally undertake more functions (marketing, sales, after sales support) and risks (warranty risk, business risk, credit risk etc.) as compared to the appellant's export transaction, their operating margins are likely to be higher than those of a company exporting under contracts with its related party. Hence, an adjustment is warranted for such differences in functions and risks. However, no adjustment has been made by the learned TPO on account of the difference in risks undertaken by the appellant vis-a-vis uncontrolled entities. 20.3 On considering of ld. AR's argument, I find that the AR has put forward the theory of marginal cost to substantiate the fact that exports made to its AE's are at arm's length. On going through the TP order dated 11-3-2005, para 12.3, I find that the TPO has rejected the contention of the appellant assigning detailed reasons. As regards ld. AR contentions, I find that the same are general in nature and nothing specific could be established. However, specific items, which are affecting the calculation of mean margin/marginal profits, have been discussed in detail and necessary findings have been given ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to bear additional operational cost of Rs. 12 crores during financial year 2001-02 whereas other comparable did not incur such expenditure. (ii) Import Duties - The taxpayer claimed that adjustment be made for the import duty paid on parts imported by the taxpayer as local comparable manufacturers were at considerable cost advantages. The taxpayer was using 80 per cent of imported parts/material as compared to 6 per cent to 39 per cent by other local comparable enterprises. (iii) For working capital employed by the taxpayer and the comparable companies - The taxpayer sought adjustment on account of funds locked up in working capital. (iv) Inventory investment - The taxpayer also sought adjustment for inventory which led to higher operating expenses in an economic sense. Therefore, while comparing enterprises financial reserves to account for difference in relative level of inventory was necessary. (v) Risk adjustment - The taxpayer contended that it exported items against confirmed orders of AEs and there was very little collection risk. The risk was even lower in comparison to sale of domestic assembly goods. 94.3 The learned CIT (Appeals) after considering facts of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as excessive and unreasonable. He, therefore, restricted it to 10 per cent against 20 per cent allowed by the Assessing Officer. The learned CIT (Appeals) further held that taxpayer was not entitled to any other adjustment on account of distribution or on account of sale of finished goods to AEs. According to the ld. CIT (Appeals), these activities did not call for any adjustments. In the light of above discussion, the learned CIT (Appeals) allowed total relief of Rs. 101,683,508 to the taxpayer as per calculations and computation available on pages 69 and 70 of the impugned order. 96. Both the parties are aggrieved and have brought the issue in appeal challenging some specific issues decided against them. 97. We have given careful thought to the rival submissions advanced before us and examined them in the light of material available on record including the impugned orders of revenue authorities. The Tribunal in its earlier decisions of Aztec Software & Technology Services Ltd. v. Asstt. CIT [2007] 107 ITD 141 (Bang.) (SB) and in the case of Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 109 ITD 101 (Delhi), considered the principles which are applicable under the Indian tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... through reimbursements but through equity contributions or through an unsecured loan, it would not have been possible for the taxpayer to claim that the said expenditure was not an operating expenditure." He further observed that all valid business deductions permissible for tax purposes may not be considered as expenditure for computing operating profit margin. Accounting Standard-12 (AS-12) was of no help in resolving this controversy. The TPO further observed that investment of spare funds of the business are commonly taken as non-operating income. He further held that the other entities taken as comparable have not received similar assistance although they have spent on advertising and marketing. 98. On appeal, learned CIT (Appeals) observed that amount received in the form of reimbursement was in the nature of an ad hoc receipt. He further observed that the taxpayer would have incurred such expenditure even if there was no receipt from its Associated Enterprise. He further held, "there is no evidence to suggest that even in the comparable cases, there was such type of receipt. Hence, by including such an abnormal receipt by way of reimbursement expenses from its foreign AEs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ubject is to be taxed if in accordance with a court's view of what it considers the substance of the transaction, the court thinks that the case falls within the contemplation of spirit of the statute... If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good. This is what this House did in the case of Secretary of State in Council of India v. Scoble [1903] 4 TC 618 (HL), that and no more. If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties, and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine." Lord Wright observed that "the true nature of the legal obligations arising out of a genuine transaction and nothing else is the substance." The aforesaid proposition has been accepted by Courts in India more particularly the Supreme Court of Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tance of the underlying transaction.": (US) Trans. Reg. §1.487-1(d)(3)(ii)(B)(1). "Greatest weight is given to "actual conduct" of the parties". : (US) Trans. Reg. §1.487-1(d)(3)(ii)(B)(1). OECD Regulations also impress upon consideration of actual contracts between the parties. 102. We are, therefore, of the view that TPO and other revenue authorities were not justified in equating this reimbursement with equity or windfall gain or subsidy or some ad hoc payment. The AE had chosen to fund the advertising campaign for products launched under the brand name "Sony". The genuineness or bona fide of the agreement has not been doubted or disputed at any stage of the proceeding. In fact it has been accepted that the agreement has been given effect to and reimbursement received by the taxpayer from Sony Pacific as per agreement. In para 11.4-5, the TPO has observed as under: "During the course of the proceedings, the counsels of the taxpayer had repeatedly emphasized the fact that the taxpayer, in the absence of commitment to receive reimbursements, would not have incurred these advertisement expenses. There is no dispute to this contention." 102.1 Moreover, the follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of such products." There is no finding that the AE of the taxpayer did not actually benefit from the advertisement carried by the taxpayer. In fact in assessment year 2003-04 in the case of taxpayer, a part of advertisement expenses have been disallowed as benefit was derived by other AE's of the taxpayer. The reimbursement it made is/was for increasing awareness of the product and its sales in Asia Pacific. The reimbursement of expenditure is admitted even by the learned CIT (Appeals) who at page 53 of the order states as under: "I find that the marketing expenditure which had been reimbursed to the appellant was nothing but a part of the operating cost of the appellant and there is no dispute on this fact." 104. The learned CIT (Appeals) however, erroneously called reimbursement an ad hoc receipt. This finding, with respect, is without any basis and is found to be contrary to material available on record including agreement between the taxpayer and its AE. The learned CIT(A) is also not correct in observing that taxpayer would have incurred these expenses even if there was no such reimbursement. This is contrary to what has already been accepted by the TPO. In our view, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... poses of its AE. It is unfair and inappropriate to treat entire cost of master production as taxpayer's operating cost without taking into consideration reimbursement received from AE for the facilities provided to the AE. The approach of the revenue authorities was stated to be contrary to the matching principle of accounting; and their decision unsustainable. Learned D.R. during the course of hearing opposed above submissions and contended that "reimbursement" and "subsidy" were used by the taxpayer itself as interchangeable terms in their submission before TPO. Therefore subsidy allowed by the A.E cannot be taken part of operating expenses of taxpayer. In reply, the learned representative of the taxpayer stated that it was only TPO who had used phrase "subsidy" in his order. The taxpayer had all along called it "reimbursement" and in this connection the taxpayer invited our attention to the following documents: (a) Financial statements filed by the taxpayer, (b) Form 3CEB, (c) Details of reimbursement and rebate transactions with AE. 105.4 On careful consideration of rival submissions of parties, we do not see any justification for not treating the amount received fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he ld. D.R. submitted that claim was not raised before the TPO and he had no occasion to examine these items. The ld. CIT(A) was wrong in examining these items and in allowing relief to the taxpayer. Accordingly she insisted upon a fresh examination and an external auditor certification be carried out and revenue be allowed to rebut the claim of the taxpayer. 106.2 After considering facts and circumstances of the case, we do not see any good ground for not permitting the taxpayer to raise the ground before the Income-tax Appellate Tribunal which is clearly arising out of the impugned order. As noted earlier, the revenue has not challenged relevant part of the order of the CIT(A). Therefore, the objection now being taken by the ld. D.R. is not justified. On merit, we see no good reason to exclude provisions written back as not forming part of computing operating profit of the taxpayer. In our considered opinion, exclusion of above provision is based upon misconception of real nature of the entry generating income. It is not practically possible for a businessman to actually disburse all expenses incurred by it in the financial year and, therefore, a large number of business liabili ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no material nor there is any finding to support action of the revenue authorities. We can therefore make a general observation that all business enterprises are making and writing back liabilities as a normal incident of operating business. The expenses for which provisions were originally made were considered operating in nature and allowed in assessment. These provisions no longer required by the taxpayer during the year under review were reversed in the books of account as per mercantile system of accounting and shown as income. Therefore on facts we do not see any justification for excluding provisions written back in the profit and loss account as not forming part of the operating profit of the taxpayer. Accordingly claim of the taxpayer is accepted. 107. The next item relates to balances written back. In our considered opinion, finding given in respect of provisions written back is equally applicable to balances written back more particularly when ld. CIT(A) has not given any separate finding and the Transfer Pricing Officer has said nothing specifically on this item. The balances written back should also be treated as part of operating profit. We direct accordingly. 108. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 08 ITR 914 observed as under:- "Held, (i) that the interest paid to the taxpayer partook of the same character as the receipts the payment of which he was otherwise entitled to under the contract and which payment was delayed as a result of certain disputes." 109.1 Having regard to the nature of receipt, we are unable to hold that interest on delayed payment could be excluded while computing operating profit of the taxpayer. In our considered opinion, the revenue authorities are not justified in excluding above receipt. We order accordingly. 110. The last item excluded in the computation of operating profit is miscellaneous income. The revenue authorities have excluded miscellaneous income on the ground that exact constitution of items of miscellaneous income was not furnished and therefore, it was not possible to consider it as operational revenue. It is not in dispute that details of misc. receipts were not furnished although while considering issues other than under the transfer pricing, some details were filed and considered. The learned representative stated that matter is different. It was explained during the course of hearing that details could not be furnished in view ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12.3.10 Proviso to section 92C(2) permits a maximum variance of 5 per cent from the Arm's Length Price. In this case, the difference of 11.48 per cent being more than 5 per cent is not acceptable. Hence, it is concluded that the price adopted by the taxpayer have to be increased by Rs. 12,025,988 which is 12.98 per cent of the value of the international transactions. The Arm's Length Price (ALP) of the sale price for exports made to Sony Japan is therefore determined at Rs. 104,676,127. 12.3.11 The Assessing Officer shall, therefore, make an addition of Rs. 12,025,988 to the total income of the taxpayer." 111.2 The taxpayer challenged above adjustment in appeal before the CIT(A). 111.3 The taxpayer claimed that 8,680 colour TVs were assembled and exported to Sony Japan to utilize idle capacity of assembling facilities to enable the company to improve recovery of its fixed assembly cost. Accordingly goods were priced taking into consideration marginal cost. The taxpayer further claimed that colour TVs were exported at ALP and this submission was supported with reference to the following chart: Particulars Local Sales Export Model KV-XA21P80 KV-XA21P80 P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from model numbers mentioned in the TPO's report. 112.1 The ld. Departmental Representative also placed the following submissions in writing on record:- "(a) The taxpayer had claimed that the export sales of CTVs to its AE were based on marginal costing as it was suffering from under-utilization of capacity. As the TPO pointed out in his order that this position was not taken in the TP report prepared under Rule 1OD, the taxpayer has contended that the fact of under-utilization of capacity was evident from the financials which was in possession of the TPO. This is a position which is completely untenable in law. The law mandates the taxpayer to prepare contemporaneous documentation to justify transfer prices based on guidelines. The taxpayer had hired an expert to do the same. The expert in his report did not consider the fact of under-utilization of capacity as a factor relevant to the determination of arm's length price in relation to the export of TVs to AE. No documents at any stage have been produced to substantiate this claim, yet it is expected that this contention would be treated with seriousness. (b) The functions, assets and risks analysis contained in the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be utilized for taking arm's length price. No error in the computation furnished by the taxpayer has been pointed out. Besides this, we are of the view that on bulk sale of 8680 colour TVs, the purchaser was entitled to some rebate of 1 to 2 per cent which is normally allowed by the producer/manufacturer on such sales. It is not correct to contend that details of domestic sales of various models were not furnished to the TPO. A copy of such detail has been placed by the taxpayer as Annexure 8A in the paper book. Only the model exported was to be taken into' account. In the light of above evidence, we are of the view that transaction of sale of CTV to Sony Japan was carried by taxpayer at Arm's Length and, therefore, adjustment made by the TPO and upheld in appeal by the CIT(A) is not called for. It is directed to be deleted. 114. In the revenue's appeal for the assessment year 2002-03, there is challenge to the deletion of Local Area Development Tax (LADT). 114.1 The TPO, while working out operating margin of profit, excluded expenses of INR 11.61 crores debited in the account for payment to Haryana Government as Local Area Development Tax (LADT). The TPO did ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n this additional argument, the finding of ld. CIT(A) can further be supported. For the reasons given above, we uphold the order of CIT(A) on this issue and rejected the ground raised by the revenue. Selection and rejection of Comparables 115. While there is no controversy on application of most appropriate method (TNMM) and in selection of filters applied by the Transfer Pricing Officer, there is big controversy on the comparables selected. The learned counsel for the taxpayer vehemently argued that Videocon Appliance Ltd. has wrongly been taken as comparable and Godrej Appliances Ltd. ("Godrej"), Carrier Aircon Ltd. ("Carrier"), Whirlpool of India Ltd. ("Whirlpool") and Hitachi Home & Life Solutions (India) Ltd. ("Hitachi") have wrongly been rejected and excluded from the list of the comparables. 115.1 As regards the other comparables selected by the TPO for assessment year 2002-03 viz., B.S. Refrigerators Ltd., Videocon Appliances Ltd. and Videocon Communication Ltd., no arguments were advanced on behalf of the taxpayer raising any objections about selection/inclusion of the said comparables. It was, however, noticed during the course of dictation/deliberation that a statemen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso submitted that same norms were not adopted by revenue authorities while taking Videocon as comparable and related party transactions of above concerns were not placed on record. The appellant was blamed for its failure to place such record of related party transactions and its possible impact on the margin of profit of these companies. (The ld. Departmental Representative has now stated in case of Videocon Appliance and Videocon International, such figures are 0.81 per cent and 3.2 per cent Respectively of total sales). Above finding has been challenged by the taxpayer as against record and it is contended that figures were placed before learned CIT (Appeals) and are noted by him vide para 19.1(iv) at page 44 of the impugned order. The related party transactions of Video con Appliances and Video con International were shown at Rs. 4.8 crores and Rs. 40.3 crores respectively. 115.3 On careful consideration of rival submissions, we see no justification for excluding above named three entities from the list of comparable for working out mean operating profit. It is an admitted position that these companies satisfy screening criteria (filters) adopted by the Transfer Pricing Offic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ggests that there should not be an overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result. As pointed out by some commentators, "most, if not all, companies experience losses at some point in their history". Losses are normal part of business; therefore, companies should not be automatically excluded from consideration because of losses." 117. It has been further argued that objection of learned CIT (Appeals) that Godrej should be excluded as it had gone for restructuring exercise to take care of an abnormal situation is misplaced since abnormal or unique losses are one which arise out of flood, fire, strike, or any other such abnormal happening, which is not the case with the Godrej. The revenue authorities were wrong in taking only high profit companies and excluding loss making companies for purposes of comparison. In the like manner DR's argument that if loss making companies are accepted as comparable then entire purpose of Transfer Pricing Regulation would be defeated is untenable. Further emphasis of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable. When a conclusion is to be reached on application of a number of factors whether such conclusion is sound or not must be determined not by considering the weight to be attached to a single factor in isolation but by assessing the cumulative effect of all the factors in their setting as a whole. Godrej in the first place is making refrigerator and not TVs. Secondly, it has suffered huge losses over a period of several years. It has recorded negative growth as admitted at pages 6 and 7 of its annual report for financial year 2000-01. It had huge unutilized capacity. It needs financial restructuring. It is carrying on disputes on account of demands raised by Punjab Small Scale Industries and Export Corpn. Ltd., apart from the disputes made by its employees for increased wages, reinstatement on termination and suspended employees. The joint venture of the company stands terminated. All this is admitted in the official report of Godrej. Besides, it is also carrying on related party transactions. Each of above factors which is considered and highlighted in the annual report, may not have a significant effect, if taken singly. However, when cumulative effect of all the factors i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ord. To appreciate above objection of the taxpayer, we refer to sub-rule (3) of rule 10B of Income- tax Rules providing for criteria for comparing an uncontrolled transaction with an international transaction as under: "10B. Determination of arm's length price under section 92C. ... (3) An uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences." 123. The aforesaid rule was examined by the Tribunal in the case of Mentor Graphics (Noida) (P.) Ltd. and it was held as under: "24. It is true that "transfer pricing" is not an exact science, evaluation of transactions through which the process of determination is carried in an art where mathematical certainty is indeed not possible and some approximation cannot be ruled out, yet it has to be shown that analysis carried was " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wing steps are to be taken while applying TNMM after selection and evaluation of controlled transactions. It is as under:- "(e) transactional net margin method, by which,- (i) the net profit margin realized by the enterprise from an international transactions entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... associated enterprises. The structure and organization of the group and more particularly the judicial relationship between different entities of same group are to be seen. The function that need to be identified while carrying comparison as per OECD guidelines include design, manufacturing, assembling, research and development, servicing, purchasing, distribution, marketing, advertising, transportation, financial and management activities. It is also necessary to examine as to what is the principal function of the entities. The analysis of comparison should consider total assets employed and assets used to earn profit. The risk assumed by respective parties is a very important consideration. It is a simple principle of economics that the greater the risk, the greater the expected return (compensation). If there are material and significant differences in the risk involved, then the comparable identified are not correct as appropriated adjustments for differences in such cases are not possible. Therefore, while performing searches for potential comparable companies, not only turnover and operating profit but functions performed and risk profile are also to be considered. However, i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to affect the price, cost charged or paid or profit arising from the transaction in the open market. It has further to be examined whether a reasonable accurate adjustment can be made to eliminate the material effect of the differences between the transactions or entities. If a reasonable accurate adjustment for the difference to eliminate material effect of the differences cannot possibly be made, then such comparables (uncontrolled) are to be rejected. 124. Valerie Amerkhail in her Commentary "Practical Guide to u.s. Transfer Pricing, Third Edition" has noted the apprehension of member countries of GECD and had quoted thus from GECD Guidelines: "Many countries are concerned that the safeguards established for the traditional transactions methods may be overlooked in applying the transactional net margin method." (DECD GUIDELINES Para 3.53.)" As emphasized by the learned author, the adjustment should be made to account for the differences that affect the net margin. The U.S. Regulations also call for similar adjustments to account for any differences that would materially affect profits under the chosen profit level indicator. The learned Author concedes that judgments about w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the learned author refers to the choice of party with respect to CPM, which is American equivalent of TNMM and the following illustration is given by the learned author to express the difficulty in the selection of the comparable: "[H56]... If one computes the profit level, for example, for a company which purchases a commodity and re-sells it, perhaps after having modified it in some way, one will derive one theoretical arm s length price for the purchase. If one computes, by the same rules, the profit level for the company, which sold the commodity to the re-seller in the first place (which would normally have been carrying on a different type of operation in another country), one will derive another price for that transaction. It is by no means obvious that the results of these two calculations will necessarily be the same or even closely similar." Para 1.20 of "OECD - Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators", 1995 states as under: "in dealings between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in determini ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ry size, Videocon International (VIL) compared to the taxpayer had several other distinctive features or differences which materially affect performance/price of the products. Comments about difference on account of possessing research and development as also valuable intangible are applicable in this case. The taxpayer unlike VIL does not have an advantage of R&D unit or valuable intangible on which it can always expect some reasonable returns. Glass Shell Panels for CTV Picture tubes, CRT Display/Video Display units, Monitors and Funnels for CTV picture tubes are important components that are integral part for manufacturing CTV units. While Videocon manufacture them, the taxpayer has to import them for further assembly in India. The huge profit VIL is making on sale of such components has been noted above. Therefore, there is material difference between the functions carried on by VIL and the taxpayer. In fact enterprises buying components from VIL and then assembling them to make TV for sale in the market are enterprises comparable to the taxpayer as those units (enterprise) are carrying on similar functions as are carried by the taxpayer and not VIL. In our considered opinion, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... R&D activity and owns intangibles. The learned CIT (Appeals) agreed that there are differences between the taxpayer and the comparables. Despite the differences, it will be wrong to conclude that appellant's earning was affected by absence of intangibles or brand name. In fact brand 'Sony' was much bigger and powerful than brands of the competitors/comparables. The ownership of brand was not material as the appellant had the benefit of the brand which is owned by its AE. The learned CIT (Appeals) was of view that no adjustments are called for on this account. 129.1 However, in respect of Research and Development, the learned CIT (Appeals) agreed that there are differences between the appellant and the comparable companies and such differences has created impact on profit margin. Consequently adjustment was reduced to 10 per cent against 20 per cent allowed by the TPO in the assessment year 2002-03. 129.2 In the next year, the learned CIT (Appeals) attention was drawn to provisions of rule 10B(3) and appellant's submission that adjustment must be made on account of difference in working capital of the appellant and other comparables. The taxpayer further claimed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er offset the additional risk faced by com parables on account of R&D and other related issues, the DR further added. The Departmental Representative also emphasized that taxpayer had the benefit of intangibles owned by its parent company. It was further submitted by the learned DR that year end data was used by the taxpayer for seeking working capital adjustment. It was not necessary that amount outstanding at the end of the year remained outstanding throughout the year. The learned DR further argued that comparables were also allowing credit to its customers and the fact that appellant had sold certain goods on credit does not imply that appellant had charged higher price. It was further argued by learned D.R. that Chinese rule prohibit the use of working capital. 131. Shri Bhutani, learned representative of the taxpayer in reply submitted that TPO had allowed adjustment of 20 per cent but on appeal CIT (Appeals) has allowed 10 per cent adjustment for R&D functions while adjustment for ownership of intangibles and risk etc. were denied. It was contended that learned DR's argument that appellant has to bear higher price/market risk, than the comparable, is without any valid f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t goods from its AE for assembly and re-sale in India. The aforesaid business decision cannot be questioned by revenue authorities. In fact the taxpayer has earned sufficient profits because of aforesaid decision. In the present case, the taxpayer in order to ensure higher quality is making import and is paying additional customs duty as compared to the other comparables. 132. We have given careful thought to the rival submissions of the parties. As noted earlier, the learned CIT(A) has allowed adjustment of 10 per cent against 20 per cent allowed by the TPO in assessment year 2002-03. We are of the view that there are differences on account of no ownership of intangibles, various risks assumed etc. in the case of taxpayer as compared with other comparables. It is by no means an easy job to evaluate the differences for each of the factor. Taking an overall view of the matter, we are of view that order of TPO for the assessment year 2002-03 allowing deduction at 20 per cent was fair and reasonable and should be upheld. 133. As regards the adjustment sought by the taxpayer on account of working capital, it is observed that the same was not allowed by the authorities below on the gr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital adjustment only in the cases of Videocon Appliances and B.S. Refrigerators to the extent of 1.16 per cent and 0.69 per cent whereas the same is required to be increased by 0.33 per cent, 0.32 per cent, 0.65 per cent and 0.05 per cent in the cases of Videocon Communications, Hitachi Appliances, Whirlpool and Carrier respectively. The net effect of such adjustment on account of working capital on the arithmetical mean of the operating margins of the comparables would be very marginal and in our opinion, the overall adjustment being allowed by us to the extent of 20 per cent of the arithmetical mean on account of intangibles etc. would take care of this marginal adjustment on account of working capital. No separate adjustment thus would be required to be made to the operating margins on account of working capital. 136. As regards the taxpayer's claim for adjustment to the operating margins of the comparables on account of higher amount of custom duty paid on imported components viz.-a-viz. the comparables, it is noticed that the working of such adjustment sought by the taxpayer is given on page Nos. 365 and 366 of the taxpayer's paper book. A perusal of the said worki ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is order while disposing of ground No. 8 of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 2 of the revenue's appeal. 140. As regards the issue raised by the revenue in ground No. 3 relating to the inclusion of foreign exchange gain in the profits eligible for deduction under section 10A/10B, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 1 of the revenue's appeal for assessment year 2002-03 being ITA No. 1257/Delhi/2007. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 3 of the revenue's appeal. 141. Ground No. 4 raised by the revenue in its appeal for assessment year 2003-04 relates to the transfer pricing issue which is being considered separately along with the relevant grounds raised by the taxpayer relating to the same issue while disposing of the appeal of the taxpayer. ITA No. 820/Delhi/2007-Taxpayer's appeal for A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ciation written back, we are of the view that if the amounts of the said liabilities and depreciation were deducted as expenditure while computing the profits eligible for deduction under section 10A/10B in the earlier years, the write-back of said amounts can appropriately/reasonably be included in the profits eligible for such deductions in the year under consideration. The Assessing Officer, therefore, is directed to verify this aspect from the past records and allow appropriate relief to the taxpayer on this issue. As regards the other miscellaneous income amounting to Rs. 1,56,732, it is observed that the details thereof are not placed on record before us and in the absence of the same, we are not in a position to decide this issue. However, in the interest of justice, we give one more opportunity to the taxpayer to furnish such details before the Assessing Officer who is directed to consider the same on merits and decide this issue afresh in accordance with law. Ground No. 4 of the taxpayer's appeal is accordingly treated as partly allowed. Transfer Pricing Issues involved in AY 2003-04 147. Ground Nos. 5 to 10 raised in the taxpayer's appeal and ground No. 4 raised ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e appellant vide para 17.3 of the impugned order. 9.6 Observing that the advertisement expenditure for which reimbursement was received was a routine operational expenditure and was in no way dependent upon the reimbursement vide para 17.3 of the impugned order. 9.7 Adjudicating Ground No. 25 taken in the Memorandum of Appeal before him for making adjustments for excessive foreign exchange losses incurred, against the appellant by observing, inter alia, in para 20.2 of the impugned order for the actual impact in profit margin rate on account of all in foreign exchange fluctuation rates could not be worked out by the appellant. 9.8 Observing that the Ground No. 25 taken in the Memorandum of Appeal before him relating to adjustments for abnormal foreign exchange losses incurred by the appellant cannot be adjudicated in violation of rule 46A of the Income-tax Rules, 1962 without appreciating the fact that the claim of adjustment did not tantamount to production of additional evidence as stipulated by rule 46A. 9.9 Observing in Para 21.3 of the impugned order that the following items while calculating the operating margins for comparison and determination of ALP be excluded:- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ADT while computing operating profit of the taxpayer. This issue also arose in this case in assessment year 2002-03 and after detailed discussion, similar order of the CIT(A) was confirmed. The facts and circumstances in the year under appeal are admitted to be identical. Therefore, order for assessment year 2002-03 is applied to assessment year under consideration also. The ground of appeal of the revenue is accordingly rejected. 151. The taxpayer in the assessment year under consideration, like in assessment year 2002-03, has raised several grounds. However, during the course of oral arguments as also in the written submissions filed by the taxpayers, certain specific issues are/were raised. These issues are dealt with herein below. Exclusion of reimbursement of advertisement expenses 152. In the period under consideration, like in assessment year 2002-03, the TPO has excluded reimbursement of Rs. 10.31 crores received by taxpayer from its AE Soni Marketing Asia Pacific (Sony Pacific) to meet part of the expenses incurred on advertising and sale promotion. The submissions of the parties in respect of this claim were the same as advanced and fully discussed in the order for ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isement expenses be made while working out operating profit of the taxpayer. 152.2 The taxpayer had also shown other income in its profit and loss account under various heads. While working out operating profit, the TPO excluded certain items as was done in assessment year 2002-03. The details of such items excluded as available in the impugned order of CIT(A) are as under:- Particulars Amount in Rs. ('000) Service Income 7,824 Scrap sales 5,263 Spares Sales 1,442 Damages for defective items 1,216 Insurance Claim 14,721 Provisions written back 7,916 Sales Tax/Service Tax Refund 431 Notice Pay Recd./Fines & Penalties from Staff 437 Membership & Subscription Received 35 Other misc. income 3,343 Total 42,627 153. On appeal, the ld. CIT(A) allowed inclusion of service income, scrap sales, spare sales, damages for defective items and insurance claims for computing the operating profit. He maintained exclusion of provisions written back, sales tax/service tax refund, notice pay received/fine and penalties from staff, Membership and subscription received and other miscellaneous items. Ld. Counsel for the taxpayer, during the course of argument, contended that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have held that scrap sales, spare sales and provisions written back represent operational income of the taxpayer. Similarly, we are of the view that the receipts from damages for defective items, insurance claim and sales taxi service tax refunds can reasonably be treated as operational income of the taxpayer applying the said guidelines and accordingly, the same can be included in working out its operating profit. 154.2 As regards notice pay and penalties received from employees, we have, however, held that the same cannot be treated as operational income of the taxpayer applying the guidelines laid down by Hon'ble Bombay High Court. On the same analogy, membership and subscription received also cannot be included in the operating profit of the taxpayer. As regards service income, we have held in the context of deduction under section 80HHC that the same does not represent operational income of the taxpayer. However, we may clarify that the service income has been held to be includible in the operating profit by the learned CIT(A) in the present context and the revenue has not challenged the said decision of the learned CIT(A) in its appeal. As regards other miscellaneous inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are similar and as transactions with the related parties, like the last year, are not likely to affect operating profit materially, these companies are included in the list of comparables this year also. 155.2 The taxpayer has again contended that Godrej Appliances Ltd. be included and Videocon International be excluded from the list of com parables in the light of directions of OECD guidelines and Indian transfer pricing regulations. The arguments addressed by the parties have been considered in detail and for the reasons given for the assessment year 2002-03, we uphold the exclusion of Godrej from the list of comparables. For the reasons given earlier in assessment year 2002-03, we accept taxpayer's contention and direct that Video con International be excluded from the list of comparables for the assessment year under consideration. 155.3 The Transfer Pricing Officer had allowed deduction of 20 per cent for taxpayer in assessment year 2002-03 to the taxpayer for not possessing any tangible R&D (research and development) facilities etc. The TPO did not allow any deduction for above factors in assessment year 2003-04. 156. On appeal, the CIT(A) thought it fit to restrict th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing +/- 5 per cent variation from determined Arm's Length Price. It was further submitted that it is mandatory for the TPO to calculate the Arm's Length Price in the light of sub-section (1) and sub-section (2) of section 92C of the Income-tax Act. 160. After considering facts and circumstances of the case, the ld. CIT(A) found no force in the submissions advanced on behalf of the taxpayer. He was of the view that there were two limbs of the provision. Its first limb deals with the situation where the Most Appropriate Method leads to more than one Arm's Length Price and in that situation the Arm's Length Price should be the arithmetic mean. Second limb of the provision, provides the facility of option to the taxpayer if price varies by an amount not exceeding +/- 5 per cent of such mean. Thus, according to the ld. CIT(A), the option is available to the taxpayer in the case where variation in price is only up to 5 per cent as found through arithmetic mean. If the variation in price is more than 5 per cent, the taxpayer has no option and Arm's Length Price shall be determined as per the first limb of the proviso. The ld. CIT(A) referred to Circular No. 12 of CBDT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officer. 162. The taxpayer being aggrieved has brought the issue in appeal before the Tribunal. During the course of hearing, ld. Representative of the taxpayer has made the following submissions:- "(i) Circular 12/2001 states that "The Assessing Officer shall not make any adjustment to the arm s length price determined by the taxpayer, if such price is up to 5 per cent less or up to 5 per cent more than the price determined by the Assessing Officer. In such cases the price declared by the taxpayer may be accepted." Hence, the circular relied upon by the learned DR simply prescribes that relief should be given to taxpayer where the arm's length price determined by the taxpayer and the Assessing Officer do not differ by more than 5 per cent. However, the Circular does not provide for the manner for determination of arm's length price. (ii) Moreover, the Circular was issued prior to insertion of the Proviso to section 92(2). Hence, it would be incorrect to assume that the Circular explains the Proviso to section 92(2). (iii) If the Proviso was intended to be in the same spirit as the Circular, the latter should have been withdrawn after introduction of the proviso. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 92C(2) of the Act which contains relevant provisions dealing with such adjustment. In order to resolve the dispute, it may be necessary to make clarificatory amendment in the proviso which unambiguously expresses the legislative intent in respect of +/- 5 per cent adjustment in ALP determination. As would be seen from the discussion made hereinafter, the legislative intent for +/- 5 per cent adjustment in ALP determination was to accept the declared transfer price if the variation between transfer price and the mean ALP was within +/- 5 per cent of mean ALP. In case, the variation between the declared transfer price and the mean ALP exceeded +/- 5 per cent of mean ALP, the transfer price was not to be accepted and transfer pricing adjustment was to be made from mean ALP i.e., for the difference between declared transfer price and mean ALP. Section 92(1) of the Income-tax Act provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Section 92C(2) of the Act provides for determination of the arm's length price by applying the most appropriate method in the prescribed manner. The proviso to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The relaxation in transfer pricing adjustments provided by the Board's Circular No. 12, dated 23-8-2001, referred to in the proceedings paragraph, was clearly intended to remove hardship to the taxpayers in whose cases the variation between the declared transfer price and the determined mean ALP was only marginal i.e., within +/- 5 per cent of the mean ALP. This relaxation was not intended to be provided to the taxpayers in whose cases the variation between the declared transfer price and the determined mean ALP was substantial and exceeded the permissible + 5 per cent range. Subsequently, the relaxation extended by the above Circular was, in substance, brought on the Statute by the Finance Act, 2002 by amending the proviso to section 92C(2) of the Act with retrospective effect from 1-4-2002 so as to provide that besides the arithmetical mean of the prices, the arm's length price shall be a price which varies from the arithmetical mean up to +/- 5 per cent. It is, thus, evident that the legislative intent of the amended proviso to section 92C(2) of the Act is to remove hardship in cases of marginal variation up to +/- 5 per cent between the transfer price declared b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 163.1 On dissection of proviso, we find that it consists mainly of two parts (limbs):- (a) Where more than one price is determined by the Most Appropriate Method, then Arm's Length Price shall be taken to be the arithmetical mean of such price; OR (b) At the option of the taxpayer, a price which may vary from the arithmetical mean by an amount not exceeding 5 per cent of such arithmetical mean. 163.2 As far as the first limb of above provision is concerned, the same has general application. Where, through the Most Appropriate Method, more than one price is determined, the arithmetic mean of such price shall be taken to be the Arm's Length Price in relation to the international transaction. As far as first limb of the provision is concerned, there is no option with nor any sort of concession allowed to the taxpayer. The Arm's Length Price so determined may be accepted or contested by the taxpayer or by any aggrieved person in accordance with the statutory provisions. It is statutory levy without any option. There is no dispute as to the interpretation of the above part or limb of the provision. 163.3 The controversy is relating to the second limb/portion of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce determined on application of Most Appropriate Method is only an approximation and is not a scientific evaluation. Therefore, the Legislature thought it proper to allow marginal benefit to cases who opt for such benefit. In the case of a taxpayer who exercises the option and accepts Arm's Length Price as per the second limb of the proviso or in other words, he accepts the Arm's Length Price even exceeding 5 per cent of Arithmetic mean determined by the tax authority as correct and is ready to pay tax on the difference between price disclosed by him and the above Arm's Length Price. We do not see any valid objection on the part of the revenue to the application of above provision to such a case. The taxpayer has exercised the option and took Arm's Length Price as per the second limb as the final price without raising any dispute. Therefore, the parameters laid down as per the second limb are fully satisfied. In our opinion, the legal position cannot be different in a case where minor variation of 5 per cent is not accepted and Arm's Length Price is further challenged in appeal. Mere fact of acceptance or non-acceptance of arithmetic mean can be taken to be the ..... 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