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TMI Blog2020 (3) TMI 471X X X X Extracts X X X X X X X X Extracts X X X X ..... e for consideration at all. We therefore set aside the order of the AO and remand the issue to the TPO for consideration of ALP of the trading segment applying the net profit margin method and if by such method the price received in the international transaction is considered as at arm s length, then no separate addition needs to be made. Determination of ALP in respect of price received by the assessee from its AE for providing sales facilitation services and for providing administrative and business support services - HELD THAT:- Due to increasing presence of composite contracts and package deals in an MNE group, the aggregation of transactions become necessary as a composite contract may contain a number of elements including royalties, leases, sale and licenses all packaged into one deal. One would usually want to consider the deal in its totality to understand how various elements relate to each other, but the components of the composite package deal may or may not, depending on the facts and circumstances of each case, need to be evaluated separately to arrive at the appropriate transfer price. Aggregation issue may also arise when looking at uncontrolled comparables. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the deduction allowed as per the provision created by the Assessee. Addition made to the book profits u/s.115JB on account of provision for warranty liability - Addition treating the same to be a liability of a contingent nature and hence liable to be added to the profit as per profit and loss account prepared in accordance with companies act to arrive at the book profit of the Assessee for the purpose of levy of tax on book profit under Sec.115JB - HELD THAT:- As already held that the provision for warrant expenses is not contingent and has to be allowed as deduction while computing income under the head Income from Business Profession . As a consequence of such finding, the addition made to the book profits is to be deleted because the liability cannot be said to be contingent. - IT(TP)A Nos. 2444/Bang/2019 - - - Dated:- 6-3-2020 - Shri N.V. Vasudevan, Vice President And Shri Pradip Kumar Kedia, Accountant Member For the Appellant : Shri Padamchand Khincha, CA For the Respondent : Shri Pradeep Kumar, CIT(DR)(ITAT), Bengaluru. ORDER PER N V VASUDEVAN, VICE PRESIDENT This is an appeal by the Assessee against the final order of assessment da ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the settled principle based on the rulings of the Honourable Supreme Court ( SC ) that where a fundamental fact permeates through more than one year and is accepted by the Revenue authorities, it should not be arbitrarily rejected. 6. The Honourable DRP and the learned AO / TPO have erred in rejecting Internal CUP as MAM by providing following reasons which are incorrect and contrary to facts of the present case: a. This method is applied by using industry average rates; and b. There is no publicly available information on prices charged in independent transactions of similar or identical nature, so External CUP cannot be applied. Notwithstanding and without prejudice to the above grounds that the Internal CUP is the MAM, 7. The Honourable DRP and the learned AO / TPO have erred in law and on facts by adopting the Transactional Net Margin Method ( TNMM ) as the MAM for benchmarking the international transaction of import of raw materials in relation to manufacturing segment. 8. The Honourable DRP and the learned AO / TPO have erred in law in adopting the following filters for conducting TP analysis: a. Rejection of comparable companies having different financi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e TPO is only to compute arm's length margin of the international transaction. 16. The Honourable DRP and the learned AO / TPO have erred in law and on facts by not appreciating that no such TP adjustment can be made in respect of AMP expenses (being legitimate, bona fide and deductible business expenditure) incurred by the Appellant towards payments to independent parties, the benefit of which accrues to the Appellant alone. 17. In this regard, the Honourable DRP and the learned AO / TPO have failed to consider that the alleged AMP expenses were incurred exclusively in relation to the Appellant's business, which is also evident from the fact that the expenditure has been accepted by the AO under section 37 of the Act. 18. The Honourable DRP and the learned AO / TPO have erred in law and on facts in concluding that the conduct of the Appellant clearly shows the presence of an arrangement for promotion of marketing intangibles . 19. The Honourable DRP and the learned AO / TPO have erred in law and on facts by not appreciating that the Appellant is a distributor of products imported from its AEs and these transactions are carried out on a principal-to-principal b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le companies. c. Scenario 3 - Net profit margin approach: The net profit margin of the Appellant is compared with the net profit margin of the comparable companies. d. Scenario 4 - Adjusted marked-up net margin approach: The net profit margin of the Appellant after considering AMP expenditure along with mark-up is compared with the net profit margin of the comparable companies. 24. The Honourable DRP and learned AO / TPO have erred in law in not considering the detailed submissions of the Appellant that even after performing an AMP expense intensity adjustment to the comparable companies, the adjusted net margin earned from the trading activity by the Appellant is at arm's length. The AMP expense intensity adjustment was affirmed by the Honourable ITAT in cases of Luxottica India Eyewear Pvt Ltd Vs. ACTT' and BMW India Private Limited Vs. DCIT2 wherein the AMP intensity adjustment is performed on the profit levels of comparable companies so as to bring them to the level of the Appellant after factoring in the differences in the intensities of AMP expenditure of the comparable companies vis-a-vis the AMP expenditure incurred by Appellant. 25. The Honourable DR ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO have erred in carrying out a search for comparable companies in order to determine the mark-up that the Appellant should have recovered from the AE in relation to the alleged AMP expenses considered to be in the nature of brand promotion service. 32. The Honourable DRP and the learned AO / TPO have erred in determining the mark-up for the alleged international transaction of brand promotion services by selecting following companies which are not comparable to the Appellant due to reasons including functional dissimilarity, failing quantitative filters, etc. a. Irunway India Private Limited b. Just Dial Limited 33. Further, the learned AO / TPO has erred in law and on facts in not accepting the following companies which are comparable and thereby not considering the detailed submissions of the Assessee: a. MCI Management India Private Limited b. Supernova Advertising Limited c. Concept Communication Limited d. Quadrant Communications Limited 34. The Honourable DRP and the learned AO / TPO have erred in not granting appropriate favorable economic adjustments (including the working capital adjustment) when computing the arm's length nature of alleged ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . MCI Management (India) Limited b. Crayon Advertising Limited c. Supernova Advertising Limited 41. The Honourable DRP and the learned AO / TPO have erred in law by not granting appropriate favourable economic adjustments (including the working capital adjustment) while calculating the arm's length margin for final set of comparable companies for these segments. V. Other TP related grounds 42. The Honourable DRP and the learned AO / TPO have erred by not carrying out the determination of arm's length price as required under section 92C of the Act read with Rule 10D of the Rules. 43. The Honourable DRP and the learned AO / TPO have failed to appreciate the Appellant's commercial judgment about the application of arm's length principle which is tied to the business realities. 44. The Honourable DRP and the learned AO / TPO have erred in law and on facts, in making several observations and findings, which are based on incorrect interpretation of law and contrary to facts of the case. VI. Disallowance of Provision for warranty 45. The Honourable DRP and the learned AO have erred in law in arbitrarily disallowing the provision for warranty amou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e same should not be treated as an unascertained liability and therefore, provision for warranty should not be added back while re-computing book profits under section 115JB of the Act. VIII. Other grounds 53. The learned AO has erred in law and on facts by not granting appropriate credit of the Tax Deduction at Source ( TDS ), as claimed by the Appellant in the return of income. 54. The learned AO has erred in law and on facts in computing interest under section 234B of the Act and section 234C of the Act. 55. The learned AO has erred in law and on facts in initiating penalty proceedings under section 271(1)(c) of the Act without concluding on whether the Appellant has concealed any particulars of income or has furnished inaccurate particulars of income or has not acted in good faith and has not exercised due diligence. The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds, at any time before or at the time of hearing of the appeal. Each of the above objections is independent and without prejudice to the other grounds preferred by the Appellant. 3. Ground I raised by the Assessee is general and requires no specific adjudicat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ich can be identified on the basis of a distinctive code. Out of 416 products, 299 products were purchased from its AEs exclusively while the rest 177 were purchased from AEs as well as from unrelated third party vendors. Products imported from AEs only (299 products) With respect to the imports from AEs only, the prices paid by AEs to its third party vendors were considered as CUP. In this regard: Out of the 299 products, 95 products were sold by the AEs on a cost to cost basis. Accordingly, the same has been considered to be at ALP. On the balance 204 products, the AEs have sold the products to Lenovo India at a price at cost plus 0.10 percent margin. However, the same was considered to within the range of + / 3 percent as permitted under the second proviso to Sec.92CA(2) of the Act. Hence, the same was considered to be at ALP. Products imported from AEs as well as third party vendors (117 products) With respect to the imports from AEs as well as third parties, the prices paid by the Assessee to third party vendors were considered as CUP: Out of 117 products imported from AEs and third parties, 52 products imported by the Assessee were at a price lower tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion was that the said case related to a Software Industry which was different from import of components/parts and that the method used in that case of external CUP and not internal CUP as in Assessee s case. The last objection of the TPO was that there was no publicly available information on prices charged in independent transactions of similar or identical nature, so external CUP cannot be applied. The reply of the Assessee on this objection was that when internal CUP is used there is no need to look at publicly available information and doing so will be against the basic feature of CUP method of determination of ALP. 7. The Assessee also submitted that for the prior AYs (i.e. AY 2006-07 to 2015-16), the Assessee had adopted CUP as MAM to benchmark its international transaction of Import of parts and components for manufacture of PCs pertaining to its manufacturing segment. The Assessee submitted that the functions performed for undertaking its manufacturing activity for all the years i.e. AY 2006-07 to AY 2015-16 have remained the same and accordingly, CUP was considered as the MAM for the subject AY as well. It was also submitted that the Hon'ble ITAT of Bangalore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y to the present AY 2015-16 also. 11. We are therefore the view that CUP should be adopted as the MAM. We direct the TPO to apply CUP as the MAM and determine ALP after due opportunity of being afforded to the Assessee. Ground II sub-grounds 2 to 6 are allowed. In view of the above conclusions the other sub-grounds 7 to 11 raised in Ground No.II does not require any adjudication. 12. Ground No. III (12) to (34) relates to the treatment of alleged excess AMP expenditure pertaining to trading segment as an international transaction and determining the ALP and making the consequent addition to the total income of the assessee. As far as the aforesaid grounds are concerned, we will take up the issue raised in ground III (13) to (22) that the AMP expenditure incurred cannot be considered as an international transaction at all. The facts which are necessary to be considered with reference to the aforesaid ground are as follows. 13. As we have already seen the assessee company is engaged in the business of manufacturing and distribution of desktop, laptop, servers and smartphones. During the relevant previous year, the assessee incurred expenditure in connection with campai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expense and is not diverse. It is factored in the net profit of the interlinked transaction. This would be also in consonance with Rule 10B(1)(e), which mandates only arriving at the net profit margin by comparing the profits and loss account of the tested party with the comparable. The TNM Method proceeds on the assumption that functions, assets and risk being broadly similar and once suitable adjustments have been made, all things get taken into account and stand reconciled when computing the net profit margin. Once the comparables pass the functional analysis test and adjustments have been made, then the profit margin as declared when matches with the comparables would result in affirmation of the transfer price as the arm s length price. Then to make a comparison of a horizontal item without segregation would be impermissible. 15. The ld. counsel for the assessee pointed out that in the present case, the TPO accepted the international transaction of trading of AE s product as at arm s length and in this regard drew our attention to para 6 of the TPO s letter dated 26.9.2018, a copy of which is at pages 934 to 972 of assessee s PB. The relevant para 6 is at page 946 in which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... termination of ALP would not arise for consideration at all. We therefore set aside the order of the AO and remand the issue to the TPO for consideration of ALP of the trading segment applying the net profit margin method and if by such method the price received in the international transaction is considered as at arm s length, then no separate addition needs to be made. In view of the above conclusion, we are of the view that sub-grounds (23) to (34) in ground III does not require adjudication at this stage. 18. Ground No.IV is in relation to determination of ALP in respect of price received by the assessee from its AE for providing sales facilitation services and for providing administrative and business support services. As far as those grounds are concerned, the first aspect which was brought to our notice is that the TPO aggregated the sales facilitation services segment and administrative business support services segment and determined the ALP. The objection of the assessee to the aforesaid approach of TPO in aggregating the aforesaid transaction was highlighted by the assessee before the DRP, specifically in objection No.7.2. In this regard, the assessee also pointe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... circumstances. If aggregation is not possible, then the ALP of the sales facilitation services segment and administrative business support services segment should be determined separately. The assessee will be afforded opportunity of being heard in this matter. In view of the above, the other grounds related to manner of determination of ALP by aggregating the above two transactions does not require consideration at this stage. 21. Ground No.V and sub-grounds (42) to (44) of ground IV are general in nature and call for no specific adjudication. 22. Ground No.VI comprising of Sub-grounds 45 to 49 deal with the grievance of the Assessee against the orders of the revenue authorities disallowing provision for warranty amounting to ₹ 73,93,02,026/-. The Assessee sells products and as per the terms of sale, the Assessee provides warranty for performance, replacement etc. Based on the past experience i.e., historical data, liability on account of probable warranty claims is provided in the books of accounts of the Assessee. During the relevant previous year, the assessee debited an expenditure of ₹ 259,83,13,924/- under the head 'Warranty Expenses. The Provision f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 51,49,28,474 108,79,40,662 103,94,28,778 56,34,40,358 2009-10 56,34,40,358 97,20,25,066 68,32,51,088 85,22,14,336 2010-11 85,22,14,336 147,74,52,660 101,70,66,189 131,26,00,807 2011-12 131,26,00,807 103,75,04,656 100,25,76,056 134,75,29,407 2012-13 134,75,29,407 148,76,96,121 135,36,26,321 148,15,99,208 2013-14 148,15,99,208 197,19,70,205 190,52,83,337 154,82,86,076 2014-15 154.82,86,076 259,83,13,924 147,92 55,949 266,73,44,051 24. Generally contingent liability is not allowed as deduction while computing income even under the mercantile system of accounting. If expenditure is to be deductib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to settling that obligation . 25. The AO examined the claim of the Assessee for deduction on account of provision for warranty expenses in the light of the principles laid down by the Hon ble Supreme Court. According to him, it was required to verify the reasonability and the reliability of the assessee's estimation of provision for warranty based on historical trend. The AO analyzed the historical trend of provision for warranty created, utilized and the percentage of the utilization / reversal to the provision created over the years which is tabulated below: Financial year Opening balance Addition during the year Utilized /Reversed during the year Closing balance %age Utilisation / Reversal over Creation 2005-06 34,94,49,249 7,66,52,762 27,27,96,487 22 % 2006-07 27,27,96,487 55,18,39,359 40,27,12,947 42,19,22,899 48 % 2007-08 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eversely, the ratio 140:100. In other words, the total provision including the opening balance should be around 140% of the actual expenditure. He thereafter tabulated the ratio between the actual expenditure and the provision and found that the ratio in the case of the Assessee was around 279:100 which according to him was highly disproportionate. He observed that the average ratio is also worked out for the earlier years and it has always been around 238:100 or more. He therefore concluded that the warranty provision created by the Assessee was unscientific and therefore unascertainable. The AO also co-related year-wise sales turnover with that of warranty provision created and utilized and came to the conclusion that sales/turnover increased from ₹ 1044.24 crores in FY.2005-06 to ₹ 1805.40 crores in FY.2007-08. Subsequently, there was drop in turnover to ₹ 1286.92 crores in FY.2008-09 with a marginal increase to ₹ 1329.58 crores in FY.2009-10. However, in terms of provision for warranty liability there was drastic increase in Warranty provision created from ₹ 61.21 crores in FY.2007-08 to as high as ₹ 108.79 crores in FY.2008-09, though there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng considered incorrect amount of provision for warranty created during the year amounting to INR 259,83,13,924. However, the amount debited to the statement of profit and loss towards warranty expenses for the FY 2014-15 is only INR 221,85,57,975, as appearing in Note 25 of the audited financial statements (relevant page of the financial statement attached as Annexure -21). The Assessee also submitted that the provision for warranty created during the year of INR 259,83,13,924, as appearing in the balance sheet of Lenovo India as on March 31, 2015, includes an amount of INR 37,97,55,949, which pertains to provision for warranty on acquisition of business from IBM India Private Limited as a going concern, as mentioned in Note 26 and Note 45 of the audited financial statements (relevant page of the financial statement attached as Annexure 22). The Assessee thus pointed out that an amount of INR 37,97,55,949 has not been debited to the statement of profit and loss for the year ended March 31, 2015 and that the same has been included in the closing provision for warranty as appearing in the balance sheet as on March 31, 2015, as a result of acquisition. Since, the Assessee has not deb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from IBM, who had substantial experience in such business. Hence if the assessee relied on the methodology followed by IBM for working out the warranty provision we cannot say that it was incorrect. There is no case for the Revenue that any provisioning made by IBM in respect of such business in any earlier years were disallowed for a reason that it was unscientific. It is true that assessee had adopted two factors namely, repair action rate and cost per claim from IBM data available at Asia Pacific Level. It might also be true that assessee had not produced records relating to IBM to show that these rates were correctly worked out by IBM. Nevertheless a look at the warranty provisioning table of the assessee for the succeeding assessment years reveals the following : There is much strength in the argument of the Ld. AR that provision done for a year should be compared with the actual spending in the succeeding year. This is for the simple reason that expenditure incurred against warranty given on sales made in any given year would be reflected in the succeeding year, when the provisioning is done on the basis of machine months. Assessee had done the provisioning based o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is not just for one year and it spreads over a period of more than 1 year and therefore the comparison as done by the revenue authorities is unsustainable. The method followed by the Assessee for creating provision for warranty has been held to be scientific and based on historical data of sales and repair ratio in every region in which the products are sold. The method has been accepted by the Tribunal in its order for several AYs. The method followed has not been shown to be not scientific by the revenue authorities. In such circumstances, we are of the view that the method followed by the Assessee should be accepted as proper and the deduction allowed as per the provision created by the Assessee. We hold and direct accordingly. 35. As far Gr.No.VII raised by the Assessee is concerned, the same relates to addition made to the book profits u/s.115JB of the Act on account of provision for warranty liability treating the same to be a liability of a contingent nature and hence liable to be added to the profit as per profit and loss account prepared in accordance with companies act to arrive at the book profit of the Assessee for the purpose of levy of tax on book profit under Sec. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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