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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 ..... the learned Transfer Pricing Officer ("TPO") under section 92CA of the Act are not in accordance with the law and made in violation of the principles of equity and natural justice and are contrary to the facts and circumstances of the present case. II. TP adjustment of INR 7,96,04,375 in relation to manufacturing segment: 2. The Honourable DRP and the learned AO / TPO have erred in law and on facts in making transfer pricing ("TP") adjustment of INR 7,96,04,375 to the returned income of the Appellant and in holding that the international transactions undertaken by the Appellant with its associated enterprises ("AEs") in the manufacturing segment were not at arm's length. Rejection of Internal Comparable Uncontrolled Price Method adopted as the most appropriate method by the Assessee: 3. The Honourable DRP and the learned AO / TPO have erred in law by rejecting the application of Internal Comparable Uncontrolled Price ("Internal CUP") method selected as the most appropriate method ("MAM") by the Appellant for benchmarking the international transaction of import of raw materials in relation to manufacturing segment, without giving any cogent and valid reasons for such re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... granting appropriate favourable economic adjustments (including the working capital adjustment) while calculating the arm's length margin for final set of comparable companies under the TNMM for the manufacturing segment. III. TP adjustment of INR 1,18,60,27,058 on account of alleged excess AMP expenditure pertaining to trading segment: 12. The Honourable DRP and the learned AO / TPO have erred in law and on facts, in making TP adjustment of INR 1,18,60,27,058 to the returned income of the Appellant by assuming the existence of an alleged international transaction of brand promotion services to AE and alleging the same to be not at arm's length in terms of the provisions of sections 92C(1) and 92C(2) of the Act read with Rule 10D of the Income tax Rules, 1962 ("the Rules"). AMP expenditure not an international transaction, 13. The Honourable DRP and the learned AO / TPO have erred in law and on facts by alleging that the unilateral Advertising, Marketing and Promotion ("AMP") expenditure, being payments made to third parties, is an "international transaction" as per the provisions of section 92B of the Act, without appreciating that they had not incurred any expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ill date, thus, all benefits endured to the Appellant, for which the Appellant has not even been paying any royalty to its AE. Consequently, for all purposes the Appellant is the sole beneficiary of all the benefits of AMP expenditure incurred during financial year ending 31 March 2015. 21. The Honourable DRP and the learned AO / TPO have erred in law and on facts, by holding that the Appellant by incurring excessive AMP expenditure has resulted in creation of marketing intangible in favor of the AE, for which it should be compensated by the AE. 22. The Honourable DRP and the learned AO / TPO have erred in law and on facts by disregarding judicial pronouncements in undertaking TP adjustments in relation to AMP. Notwithstanding and without prejudice to the above grounds that the AMP expenditure incurred by the Appellant does not constitute an international transaction under Chapter X of the Act, the Appellant craves to raise following grounds of objections on merits. 23. The Honourable DRP and the learned AO / TPO have erred in disregarding the Appellant's submission that the Appellant would operate at arm's length under following scenarios using RPM and TNMM for tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AO / TPO have erred in law and on facts by characterizing the incurrence of AMP expense as a provision of brand promotion services by the Appellant to its AE requiring a mark-up. 29. The Honourable DRP and the learned AO / TPO have erred in law and on facts in not appreciating that the Appellant has not provided any value added / brand building services to its AE by incurring AMP expenses, and therefore, no mark-up could have been charged / levied on such expenses, even if the same was to be characterized as an 'international transaction'. 30. The Honourable DRP and the learned AO / TPO have erred in not appreciating that in view of the Appellant being contractually assured of a margin after cost recovery, the entire AMP expenditure has in fact been recovered from the AE and hence adjustment could only be restricted to markup, that too if the operating margin of the company was not at arm's length. That the Honourable DRP and the learned AO / TPO have erred in not appreciating that the cost is recovered is evident from its contract, and the extract from the inter-company distribution agreements is reproduced below for your Honours ready reference: "The parties i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e benchmarking for both the segments and thereby failing to appreciate that the services rendered by the Appellant to its AEs in each of these segments are separate and distinct and accordingly needs to be benchmarked separately. 37. The Honourable DRP and the learned AO / TPO have erred in law in rejecting the TP documentation of the Appellant as "not reliable or correct", under section 92C(3) of the Act, merely because the learned TPO did not agree with the positions and filters adopted by the Assessee in its TP documentation, and adopted certain additional filters / modified filters in selecting the comparable companies by using non contemporaneous data of the said companies. 38. The Honourable DRP and the learned AO / TPO have erred in law in adopting the below filter for conducting TP analysis: a. Rejection of comparable companies having different financial year ending (other than 31 March 2015) 39. The Honourable DRP and the learned AO / TPO have erred in not rejecting the following companies despite the same not being comparable to that of the Assessee due to various factors such as functional dissimilarity, product / intangible led revenues, failing learned TPO' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anty accrual processes and the industry requirement in which the Appellant operates. 48. The Honourable DRP and the learned AO have erred on facts in failing to consider that the Appellant has provided for warranty on a scientific and consistent manner every year applying the principles laid out by the Honourable Supreme Court ("SC") in the case of Rotork Controls India Privat and therefore such expenditure is an allowable deduction under section 37 of the Act. 49. The Honourable DRP and the learned AO have erred in appreciating that the Appellant provides warranty for a period from one year to four years on its products and accordingly, the entire provision could not be utilized in one year and has to be spread over multiple years. VII. Addition of provision for warranty to the book profits 50. The learned AO has erred in adding back the warranty provision created during the relevant AY amounting to INR 73,93,02,026 to the book profit of the Appellant. 51. The Honourable DRP and the learned AO have erred in law and on facts in holding that the warranty provision of INR 73,93,02,026 is an unascertained liability and therefore, not appreciating that the warranty provision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... determined have regard to Arm's Length Price (ALP) as laid down in Sec.92 of the Income Tax Act, 1961 (Act). The Assessee also imported parts and components from third parties. The methodology adopted by the Assessee for benchmarking the price paid to the AE for import and components was as follows: Nature of international transaction MAM Value as per books of accounts ALP as determined by Assessee Remarks Import of parts and components for manufacture of PCs CUP 1,484,262,448 1,462,645,707 Suo-moto adjustment of INR 21,616,741 is made in the Return of Income for prices not at ALPS It can be seen from the aforesaid chart that the Assessee chose Comparable Uncontrolled Price (CUP) as the Most Appropriate Method (MAM) for determining ALP i.e., it compared the price it paid for import of parts and components from unrelated persons (CUP) with the price paid for import of parts and components to the AE. In its Transfer Pricing Analysis (TP Analysis), the Assessee considered itself as assuming most of the risks including market risk, inventory risk, credit and collection risk, forex risk, warranty and idle capacity risk. Based on the functions and risks performed, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such reliable data was not available. The reply of the Assessee in this regard was that each of the component/parts were identified with a unique identification number and the details were captured in the TP Analysis. The second objection of the TPO was that the Assessee used weighted average of price of components/parts imported throughout the year and therefore it cannot be said that the method adopted by the Assessee was CUP as weighted average price is not the actual price in the controlled and uncontrolled transaction. The Assessee's reply in this regard was that the components/parts were imported throughout the year and were large in number. It was practically impossible to compare each and every import transaction. It was the plea of the Assessee that the price would depend on quantity imported and used in the manufacture of computers and hence weighted average would be the most appropriate price that should be chosen for comparison. In support of its contention that weighted average price is more appropriate the Assessee relied on decision of ITAT Mumbai Bench in the case of Gharda Chemicals Ltd. 2009 TIOL 790 (Mumbai- ITAT) and Audco India Ltd. 47 SOT 420. The third reaso ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has raised Grd.No.II before the Tribunal. We shall first take up Gr.No. II sub grounds 2 to 6 which grounds relate to the contention of the Assessee that CUP should have been accepted as the MAM. We have heard the rival submissions. As far as the issue of MAM in the case of the Assessee in the transaction of import of components is concerned, we have already extracted the reasons assigned by the TPO for rejecting CUP as MAM and the reasons given by the Assessee as to why the reasons assigned by the TPO are unsustainable. 10. In AY 2006-07, the Tribunal has in its order dated 30.5.2016 in IT (TP) A.No.582/Bang/2015 upheld the DRP's direction that CUP is the MAM to be applied in the case of the Assessee. In AY 2007-08, the DRP upheld CUP as the MAM and the department did not file any appeal against that order of DRP before the Tribunal. In AY 2008-09 the TPO vide his order dated 31.10.2011 accept Assessee's adoption of CUP as MAM and also accepted that price paid in the international transaction to the AE is at Arm's Length. In AY 2009-10 in ITA(TP)A.No.74/Bang/2014 order dated 6.7.2018 the Tribunal upheld order of the DRP accepting CUP as MAM. In AY 2010-11 the Tribunal in IT(TP)A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method. The TPO chose 9 comparable companies and arrived at the AMP to sales of those companies and compared the same with that of the assessee. By such comparison, the TPO came to the conclusion that assessee was incurring much higher AMP expenditure than the industry average and incurring of excessive AMP expenses constitutes an international transaction of promotion of AE's brand. The TPO concluded that assessee performed additional functions which promoted the marketing intangibles of the AE and that the assessee should have been reimbursed by the AE the additional expenses along with mark-up. In other words, the TPO adopted the Brightline Test in making the aforesaid addition. The DRP upheld the order of the TPO. 14. The ld. counsel for the assessee submitted before us that incurring of AMP expenses does not constitute an international transaction and in this regard filed before us a copy of the decision of the Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communications India P. Ltd. v. CIT, 374 ITR 118 (Del). Our attention was drawn to para 101 of the aforesaid decision in which the Hon'ble Delhi High Court held that once the TPO accepts and adopts TNM Meth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dated 14.11.2018 passed by the TPO u/s. 154 of the Act wherein the fact that AMP expenditure is in relation to trading segment only has been accepted by the TPO. His next submission was that the assessee has also demonstrated in its TP study with regard to the trading segment that the net margins earned by it were at arm's length. In this regard, the ld. counsel for the assessee brought to our notice that even before the TPO, the assessee had given the net margins by way of alternative submission and those details are at pages 1392 and the computation is at page 1540. Our attention was drawn to the fact that Scenario-3 was projected by the assessee in which the net margin of the comparable companies was arrived at 2.62% and the assessee's net profit margin was 1.45% which was within the +/- range permitted under proviso to section 92CA(2) of the Act. 17. We have considered his submission and are of the view that it would be just and appropriate to set aside the issue of determination of net margin of the assessee and in the trading segment, as claimed by the assessee in Scenario-3 before the TPO. If the margins are accepted as at arm's length and then applying the principles laid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion' principle. 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. This is because third party information is not often available at the transaction level. In such circumstances, entity level information is the only recourse available. Therefore, whether ALP-principle is to be applied on a transaction by transaction basis or on an aggregation basis depends on the facts of each case and is not universally or generally applied in all composite contracts involving multiple transactions. 20. Since this specific objection of assessee has not been met by the TPO/DRP, we deem it fit and prope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or of the unexpired warranty period in months and the number of PCs which are under warranty at the end of the year; Repair rate is the percentage of claims out of the total sales made on the historical data for the region; and Cost per claim is the average expected repair cost per PC on historical data for the region. The Provision for warranty liability created in the books and the actual liability on account of warranty liability incurred in each of the Financial years from 2005-06 is as follows: Financial year Opening balance Addition during the year Utilized/Reve rsed during the year Closing balance 2005-06 - 34,94,49,249 7,66,52,762 27,27,96,487 2006-07 27,27,96,487 55,18,39,359 40,27,12,947 42,19,22,899 2007-08 42,19,22,899 61,21,80,442 51,91,74,867 51,49,28,474 2008-09 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative 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 42,19,22,899 61,21,80,442 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 08. Subsequently, there was drop in turnover to Rs. 1286.92 crores in FY.2008-09 with a marginal increase to Rs. 1329.58 crores in FY.2009-10. However, in terms of provision for warranty liability there was drastic increase in Warranty provision created from Rs. 61.21 crores in FY.2007-08 to as high as Rs. 108.79 crores in FY.2008-09, though there was fall in turnover from Rs. 1805.40 crores in FY.2007-08 to Rs. 1286.92 crores in FY.2008-09. Thus, provision created has increased from 3.34% of turnover to 8.40% of turnover in FY.2008-09. The AO also found a reverse situation where there was provision created had fallen from Rs. 108.79 crores in FY.2008-09 to Rs. 97.20 crores in FY.2009-10, inspite of increase in turnover from Rs. 1286.92 crores in FY.2008-09 to Rs. 1329.58 crores in FY.2009-10. Here, provision created has fallen from 8.40% to 7.31% in FY.2009-10. According to the AO, even if it is presumed that the reason for increase in provision created was due to increase in service cost including labor, travelling expenses, etc., the same does not justify the fall in provision created in the very next year though there is increase in turnover. 27. According to the AO, the Warr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 debited such amount to the statement of profit and loss, the same has not been deducted in computing the taxable income. It was thus submitted that the learned AO has erred in facts by disallowing an amount of INR 259,83,13,924 instead of INR 221,85,57,975 towards provision for warranty created during the year. Therefore, at best the learned AO could have disallowed INR 73,93,02,026 on account of provision for warranty i.e., after allowing the actual expenditure incurred during the year. The above argument was without prejudice to the Assessee's argument that the entire provision for warranty liability should be allowed as deduction. 29. The DRP upheld the order of the AO in principle but held that the disallowance should be a sum of Rs. 110,90,13,924/- which is the difference between the provision created during the relevant previous year of Rs. 259,83,13,924 and the warranty liability that was ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. 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 on machine months. If by application of the formula of multiplying machine months with repair action rate and cost per claim, an excessive warranty provisioning had resulted, then definitely in the succeeding year the expenditure incurred on warranty would be much less. The table above would show that expenditure on warranty was higher in almost all succeeding years except financial year 2009-09. In such circumstances we cannot say that assessee had followed a method which was not scientific. We are of the opinion that the three conditions set out by the Hon'ble Apex Court in the case of Rotork Controls India (Pvt) Ltd have been satisfied by the assessee, viz., establishing that there is a present obligation on account of a past event, working out the probable estimate of the outflow of the resources required and substantiating the reliability of such estimate. Especially so since the assessee was mandatorily required to f ..... X X X X Extracts X X X X X X X X Extracts X X X X
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