9911796707
TMI Blog2021 (11) TMI 1059X X X X Extracts X X X X X X X X Extracts X X X X ..... lied components for the automobile industry. (iii) Services segment In the services segment, the assessee renders application / specific services to its Associated Enterprises ("AEs") with regard to development of software. 3. During the AY 2012-13, several international transactions took place between the assessee and its AEs, including purchase of raw materials for the manufacturing segment and the aforesaid provision of SWD services and in the course of assessment, the AO made a reference to the TPO for examination of the arm's length price of the aforesaid transactions. 4. On such reference, the TPO passed an order dated 25.01.2016 under Section 92CA of the Income-tax Act, 1961 ("the Act") determining the TP adjustment with respect to manufacturing segment as Rs. 89,85,85,564/- and the TP adjustment with respect to software development services ["SWD services"] segment at Rs.11,77,20,997/- totalling to Rs.101,63,06,561/-. 5. In the draft assessment order dated 28.03.2016 the aforesaid TP adjustment was incorporated, apart from the additions on account of disallowance of provision for warranties and R&D expenses. 6. Aggrieved, the assessee filed its objections before the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts were made to the operating cost: * costs associated with unutilised capacity. * costs on account of high customs duty 12. On making the above mentioned adjustments, the assessee arrived at a margin of 6.34% as against -11.66% arrived at by the TPO. Though the TPO accepted the comparables selected by the assessee, he did not grant an adjustment for under-utilisation of capacity and an adjustment for expenses incurred towards customs duty. The TPO also treated amortization of goodwill as an operating expense while computing the margin of the Appellant. Filters applied by assessee in its TP study: Step Description 1. Companies for which the latest data available was for a period ended prior to 31.03.2010 - rejected 2. Companies reporting net sales >Rs. 1 crore - selected 3. Companies with positive net worth - selected 4. Companies reporting average manufacturing income/average net sales>50% - selected 5. Companies which were functionally comparable - selected 6. Companies with related party transactions less than 10% of sales - selected Comparables selected by assessee and their arithmetic mean: Sl. No. Name of the company Weighted Average Margin (%) 1. A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee to acquire new customers. This resulted in underutilization of the production capacity in the factory, resulting in low utilization of the available capacity for the FY 2011-12 to manufacture the products. The assessee operated at 40.39% of its installed capacity whereas the comparable companies chosen by the assessee operated at an average of 77.42%. It is evident from the capacity utilization of 40.39% that the assessee had under-utilized its capacity considering low demand for its products. Hence, the assessee could not manufacture at optimal capacity and recoup the fixed expenses for the year and the adjustment for under-utilization of capacity is warranted. 18. The ld. AR submitted that the TPO did not grant an adjustment for capacity utilization on the ground that that the adjustment would have to be made to the comparable companies and not the tested party and that the capacity utilisation of each of the comparable companies has not been considered. The TPO held that the data considered by the assessee to compute the adjustment pertained only to 6 out of 11 companies and that the capacity utilisation for FY 2011-12 of the tested party is taken for the comparable comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te and credible evidence in this regard. In the relevant case law, since Haworth India had not been able to furnish credible and accurate information with regard to capacity utilization, the adjustment was not allowed. However, in the assessee's case, it has provided all information practically possible. Sufficient evidence has been provided in the form of capacity data of comparable companies as well as industry average from the Federation of Indian Chambers of Commerce & Industry ("FICCI") survey report. Hence principally capacity utilization adjustment should have been granted. The assessee also relies on the following judicial precedents in this regard:- * Global Vantedge P. Ltd. v. DCIT reported in [2010] 37 SOT 1 (DELHI) * ITO v. CRM Services India (P) Ltd reported in [2011] 14 taxmann.com 96 (Delhi) * CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay). * Transwitch (India) Pvt. Ltd. v. DCIT reported in [2012] 21 taxmann.com 257 (Delhi - Trib.) * Capgemini India Private Limited v. ACIT reported in [2013] 33 taxmann.com 5 (Mumbai - Trib.) * ACIT v. Fiat India (P.) Ltd. [IT Appeal No.1848 (Mum) of 2009, dated 30-04-2010] * Amdocs Busines ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een realized. In the case of the tested party (assessee), it is not permissible to deviate from the book results on the ground of capacity utilization and observing that "The perusal 'of the above provision will reveal that every person who is entered into an international transaction is under an obligation to keep and maintain the information and document with respect to the assumptions, policies and price negotiations, if any, which have critically affected the determination of the arms length price. The TPO in his report has observed that assessee did not submit any evidence for assuming the capacity utilization of the comparables and whatever data relied upon by the assessee for seeking capacity utilization adjustment was either unreliable or incorrect. When fixed cost itself is incurred only for a part of the year the same cannot be adjusted for differential capacity utilization". 23. Further, the ld. DR relied on the order of the Tribunal in the case of Flinth Group (India) Pvt. Ltd. v. ITO in IT(TP)A No. 3285/Bang/2018 dated 31.10.2019 wherein it was held as under:- "5. We have perused submissions advanced by both sides in the light of records placed before us. Indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - Trib.) it was held that:- "5. ........... Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment." (iii) In the case of Biesse Mfg. Co. Ltd. v. Asstt. CIT 12016] 69 m 428 (Bang. - Trib.) the Tribunal held as follows: "10.4.1 We have heard the rival contentions and perused and carefully considered the submissions made and material on record; including the judicial pronouncements cited. The issue for consideration is whether adjustment for underutilisation of capacity is allowable in the case on hand and if so, the manner of computation thereof and the quantum of adjustment ........... 10.4.5 In the above cited case of the Mumbai Tribunal i.e. Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , whether the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don't restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/ transactions as per sub-clause (i) of rule 10B(1)(e) of the Rules itself The absence of specific provision in Rule 10.13(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been. upheld in the following decisions:- * Capgemini India Pvt. Ltd. v. Asstt. CIT 12014 33 taxmann.com 5/120141 147 ITD 330 (Mum. - Trib.) * Demag Cranes & Components (India) (P.) Ltd. v. Dy. CIT 12014 17 taxmann.com 190/49 SOT 610 (Pune) 32. As far as data of comparable companies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mphasis Supplied) 35. Accordingly, we direct the TPO to exercise powers under section 133(6 * the Act to call for information on capacity utilization of the companies such as - * Installed Capacity, * Actual production in Units, * Break up of Fixed Cost and Variable Cost; * Segmental/ product wise information, if any. 36. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No. 7 is decided accordingly. Respectfully following aforestated observations, we direct Ld.TPO to exercise powers under section 133(6) of the Act and call for relevant information on capacity utilisation in case of comparables finally selected. Needless to say that details so collected by Ld.TPO shall be provided to assessee and then to provide consider the issue as per law. Accordingly this ground raised by assessee stands allowed for statistical purposes." 24. We have heard both the parties and perused the material on record. In this case, the exact details of capacity utilisation of comparable companies was not made available to the TPO. It was alleg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 27. The assessee submits that the import of raw materials is not a commercial decision but on the other hand is necessitated for reasons beyond the assessee i.e., by lack of capacity to localize the procurement which the assessee is still in the process of doing. Reliance is placed on the following decisions in support of the Appellant's contentions. * Skoda India Pvt. Ltd. v. ACIT reported in [2009] 30 SOT 319 (Pune) * Putzmeister Concrete Machines Private Limited v. DCIT reported in [2014] 49 taxmann.com 436 (Panaji - Trib.) * Toyota Kirloskar Motors Pvt. Ltd. v. ACIT reported in [2012] 28 taxmann.com 293 (Bangalore) 28. In this connection, the assessee's import consumption vis-à-vis the imports of comparable companies and the assessee are as below:- Sl. No. Name of the company Imports/Total purchases (%) (3 year average) 1. Automotive Stampings & Assemblies Ltd 0.57 2. Bajajsons Ltd 5.92 3. Bharat Gears Ltd 2.62 4. JMT Auto Ltd 1.54 5. M&M Auto 0.53 6. Rambal Ltd 2.10 7. Rasandisk Engineering Inds. India Ltd 4.61 8. Triton Valves 10.81 9. Wheels India Ltd 8.63 10. Mubea Suspension India Ltd 0.02 11. Ring Plus Aqua Ltd 4.75 & ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . v. Asstt. CIT [2016] 73 taxmann.com 235 (Chennai - Trib.) wherein held that: '6.1 At this stage, it is pertinent to mention the finding of the Pune Bench in the case of Demag Cranes & Components (India) Pvt. Ltd. v. DCIT (supra) dated 4.1.2012 in ITA No.120/PN/2011, which is as follows : "37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). It is relevant mentioned that we have already analysed the relevant provisions of Income Tax rules vis a vis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of the 'working capital'. In principles, our findings on the issue remain applicable to the adjustments on account of the import cost mentioned in ground 4(b) too. The difference between the AL Margin before and after the said adjustments on account of 'import cost' works out to 0.57% (7.18%-6.61%). Revenue has not disputed the said working of the assessee. In these factual circumstances and in the light of the scope of adjustments discussed above, in our opinion and in principle, the assessee should win on this ground too. One such decisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... made and reasonable assumptions are to be made. The argument before us was that it was first year of assessee's operations and complete facilities ensuring a reasonable indigenous raw material content was not in place. The assessee's claim is that it was in these circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car was computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were before any of the authorities below. What was argued before the AO was mere fact of higher costs on account of higher import duty but then this argument proceeded on the fallacy that an operating profit margin for higher import duty is permissible merely because the higher costs are incurred for the inputs. That argument has been rejected by a Coordinate Bench and we are in respectful agreement with the views of our esteemed colleagues. This additional argument was not available before the authorities below and it will indeed be unfair for us to adjudicate on this factual aspect without allowing the TPO to examine all ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction at a different exchange rate. This does not affect the transaction which has already taken place. Further, it is submitted that the foreign exchange gain or loss and hedging cost will vary depending on the risk management policy and on the hedging cost a company is willing to bear. The foreign exchange fluctuation computed as per Accounting Standards ("AS") 11 takes into account the realization loss/gain (fluctuation due to differences between invoice and payment exchange rates) and revaluation loss/gain (translation of closing balances at the year-end exchange rate). However, such exchange fluctuation does not take into account any adverse exchange fluctuation due to depreciation of Indian currency on a year-on-year basis. The adjustment now being sought for by the assessee is on account of the foreign exchange fluctuation loss which is embedded in the raw material import cost. It is submitted that due to stricter quality norms and necessity for adherence to the global quality standards, the assessee had to import from its group affiliates/foreign unrelated suppliers and therefore localisation of such high quality raw materials had not occurred during the assessment ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the TPO. 37. It is submitted that in comparison to the assessee, the comparable companies who are established players in the automobile market, have negligible import content due to indigenization of materials required for production. The assessee contends that due to stricter quality norms and necessity for adherence to the global quality standards, the assessee had to import from its group affiliates/foreign unrelated suppliers and therefore localisation of such high quality raw materials had not occurred during the assessment year in question due to several factors. In this connection, the assessee's import consumption vis-à-vis the imports of comparable companies selected by the TPO and the assessee are as below for the FY 2011-12. 38. The ld. DR submitted that the assessee incurred foreign exchange loss of Rs.284.98 million which is considered by the TPO as non-operating. The TPO has also considered the foreign exchange fluctuation as nonoperating in the case of comparables. This takes care of the differences with regard to foreign exchange fluctuation. Accordingly no further adjustment on this count was required. 39. This issue was also considered by the Chennai T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etermination of operating margin of the manufacturing segment for transfer pricing purposes. 42. It is submitted that for the purpose of net margin computation, only the income and expenditure in connection with the business operations of the company is to be considered. In the present case, goodwill has resulted on account of an extra-ordinary circumstances involving merger of an automotive components business of Seimens Limited and amortization of goodwill is due to such extraordinary circumstances. Hence, amortization of goodwill should not be considered as operating expenses. Detailed submissions in this regard are placed at pages 224-225 and 1604 of the paperbook. 43. Reliance in this regard is placed on the decision of the Delhi Bench of this Tribunal in ST Ericsson India Pvt Ltd v. DCIT (order dated 03.07.2018 in ITA No. 609/Del/2015) where it was held that amortization of goodwill is an extraordinary item and is not pertaining to the regular operations of the assessee, and hence non-operating in nature. 44. The ld. DR submitted that the DRP has already held that depreciation of the comparables should be brought to same rate of depreciation of the operating cost of the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of this Tribunal in favour of the assessee. It was submitted that the mandate in Chapter X of the Act is only to re-determine the consideration received or given to arrive at income arising from an International Transaction with Associated Enterprises. In respect of transactions with non-AEs, Chapter X of the Act has no role to play and therefore to make an adjustment including the non-AE transactions is erroneous and contrary to the provisions of the Act. Reliance is placed on the following decisions in support of the above contention of the Appellant: * IL Jin Electronics (I) (P.) Ltd v. ACIT reported in [2010] 36 SOT 227 (DELHI) * M/s Tupperware India Private Limited (ITA No. 2140/Del/2011 and 1323/Del/2012) * IKA India Private Limited v. ACIT reported in [2019] 101 taxmann.com 276 (Bangalore). * CIT v. Alstom Projects India Limited reported in [2017] 88 taxmann.com 465 (Bombay) * Alstom Projects India Limited v. CIT reported in [2013] 36 taxmann.com 130 (Mumbai - Trib.) * CIT v. Thyssen Krupp Industries (P) Limited reported in [2016] 70 taxmann.com 329 (Bombay) * Claas India Pvt. Ltd., - ITA No.3883/Del/2010 * CIT v. Petro Araldite Pvt. Ltd reported in [2018] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 56,66,07,292 TOTAL 204,04,22,463 Operating revenue Sale of automotive components 21,77,46,807 52. Thus, in the manufacturing segment, the international transactions related to the expenses are to the extent of 204,04,22,463 and in respect of revenue are to the extent of 21,77,46,807. The object of applying the TNMM at the manufacturing segment level, by considering the comparable engaged in the manufacturing function, is to find out the negative influence on the assessee company due to the international transactions related to cost and revenue by comparing the margin of the segment with the mean margin of the independent comparables. Therefore, it is not appropriate to restrict the adjustment to the AE cost or revenue. In the case of the assessee, the ALP margin has been worked out by the TPO at 6,94% and by applying that margin, he arrived at the conclusion that the operating cost should have been at 2449,57,84,436 as against the operating cost which works out to 2539,43,70,000 based on segmental information, which makes it clear that the international/ transaction related to cost of 2204,04,22,463 adversely influenced the profit margin of the manufacturing segment of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing the margin of the assessee for the services segment, treated amortization of goodwill as operating in nature and consequently computed the margin for the segment as 5.31% as against 8.35% computed by the assessee in its TP study. As stated above whilst dealing with ground no. 7 under the manufacturing segment, it is submitted that for the purpose of net margin computation, only the income and expenditure in connection with the business operations of the company is to be considered. In the present case, goodwill has resulted on account of an extra-ordinary circumstances involving merger of an automotive components business of Seimens Limited and amortization of goodwill is due to such extraordinary circumstances. Hence, amortization of goodwill should not be considered as operating expenses. Detailed submissions in this regard are placed at pages 224-225 and 1604 of the paperbook. 58. Reliance in this regard is placed on the decision of the Delhi Bench of this Tribunal in ST Ericsson India Pvt Ltd v. DCIT (order dated 03.07.2018 in ITA No. 609/Del/2015) where it was held that amortization of goodwill is an extraordinary item and is not pertaining to the regular operations of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons in this regard are made at pages 320-327and pages 642-645 of the paperbook. He submitted that the DRP, however, failed to properly appreciate the assessee's submissions in this regard and thereby upheld its inclusion in the list of comparables. 64. Reliance in this regard is placed on the decision of this Tribunal in EMC Software and Services India Private Limited v. ACIT ITA 523/Bang/2017 (Order dated 03.07.2019) wherein L&T was excluded from the final list of comparables. Reliance is also placed in the case of an Assessee placed similar to the assessee in CGI Information Systems & Management Consultants (P.) Ltd. v. ACIT [reported in (2018) 94 taxmann.com 97 (Bangalore - Trib.)] wherein, the company was directed to be excluded. Thus, it is submitted that L&T Ltd. ought to be excluded from the final list of comparables. 65. The ld. DR submitted that that the company cannot be excluded by application of upper turnover filter as the ground relating to the same has been rejected by the revenue authorities. Further, the related party transactions are less than 25%, and the DRP upheld the application of 25% related party transaction filter applied by the TPO. Therefore the object ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Report:- EXPENSES Employee benefit expenses O(i) 17,700,804,103 Operating expenses O(ii) 2,233,789,603 Sales, administration and O(iii) 3,466,224,349 23,400,818,255 Operating profit 6.284,714,851 Finance Cost 358,026,704 P. FINANCE COST P(I) Interest paid on Fixed loans 909,998 On others 75,544,203 Lease finance charges 397,440 76,851,641 P(ii) Exchange loss on borrowings (net) 281,175,063 Total finance cost 358,026,704 67. She therefore submitted that there is a mistake in computing the operating margin of L & T Infotech Ltd. with regard exclusion of finance cost and foreign exchange loss. Accordingly, the DRP has directed the AO to rectify the mistake, after due verification, while giving effect to the directions of its order. Persistent Systems Ltd. (Persistent) 68. As regards Persistent Systems Ltd., the ld. AR submitted that this company is functionally dissimilar and ought to have been excluded from the final list of comparables. The assessee has objected to the inclusion of Persistent on the ground that Persistent is engaged in SWD services as well as development o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reasons. The turnover of Persistent Systems is significantly higher than the assessee and hence, Persistent Systems has to be rejected based on the application of the upper limit of turnover criteria. Persistent Systems fails related party transaction ("RPT") filter and therefore, it should be rejected. The Company has the presence of extraordinary events during the year. The learned Transfer Pricing Officer ("TPO") has erred in computation of markup of the Company. 71. The ld. DR submitted that this company was rejected on application of upper turnover filter and upheld the application of the related party transaction filter applied by the TPO. Hence, the contention regarding the turnover and related party transaction filter are not acceptable. With regard to the functions, on perusal of page no.164 of the Annual Report, it is noticed that "the company is predominantly engaged in outsource software product development services, the company offers complete product life cycle" which is further evident, from Note 21 to the financial statements, according to which the entire revenue is from sale of software services. 72. With regard to the extraordinary event, it is noticed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ibunal held on the comparability of the 3 companies which the Assessee seeks to exclude as follows: (a) * ..... * ...... * (b) Larsen & Tourbro Infotech Ltd., was excluded from the list of comparable companies by relying on the decision of the Delhi Bench of ITAT in the case of Saxo India (P.) Ltd. v. Asstt. CIT [2016] 67 taxmann.com 155 (Delhi - Trib .). The discussion is contained in paragraphs 4.8 to 4.10 of the Tribunal's order. The Tribunal held that L & T Infotech Ltd., was a software product company and segmental information on SWD services was not available. The Tribunal also noticed that the appeal filed by the revenue against the tribunal's order was dismissed by the Hon'ble Delhi High Court in ITA No.682/2016. (c) Persistent Systems Ltd., was excluded from the list of comparable companies on the ground that this company was a software product company and segmental information on SWD services was not available. The Tribunal in coming to the above conclusion referred to the decision rendered by ITAT Delhi Bench in the case of Cash Edge India (P.) Ltd. v. ITO ITA No.64/Del/2015 order dated 23.9.2015 and the decision of Hon'ble Delhi High Court in the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omparable for the assessment year 2009-10. It is submitted that that there is no change in the facts pertaining to the company, and therefore Akshay ought to be included in the final list of comparables. Detailed submissions in this regard are placed at pages 358364 of the paperbook. 78. The ld. DR submitted that from the Director's report, it was noticed that the company is engaged in professional services and ERP services. However, the entire revenue has been shown as income from software services in the absence of segmental information with regard to two functions performed by the company, it cannot be retained as a comparable, hence the rejection is accordingly to be upheld. 79. We have heard both the parties and perused the material on record on this issue. The assessee has filed financials of Akshay Software Technologies Ltd. The revenue from operations is shown as follows:- 80. This company was considered as comparable in the case of Arowana Consulting Ltd. v. ITO in IT(TP) A No. 235/Bang/2015, order dated 29-6-2015, wherein it was held as under:- "12.3 We have considered the rival submissions as well as the relevant material on record. As regards the decision of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is directed to consider Akshay Software Technologies Ltd. as a comparable. Technosoft Engineering 82. The ld. AR submitted that this company was proposed by the assessee as an additional comparable before the TPO and was rejected on the ground that the functions of the company were more in the nature of engineering design services. Before the DRP, the assessee demonstrated that the company was engaged in software designing services. However, the DRP upheld the order of the TPO on the ground that it was unclear whether the company renders software development services. In this regard, it is submitted that a perusal of the annual report of the company would demonstrate that the company is engaged in software designing which is nothing but software development. The website extracts of the company also support the said submission. It is therefore submitted that the company is functionally comparable and that it passes all the filters applied by the TPO. Detailed submissions in this regard are placed at pages 376-386 of the paperbook. 83. The ld. DR submitted that the assessee failed to furnish the complete Annual Report to establish that the company is functionally comparable. Even ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l year ending of the company was 31st March 2012 as in the case of the assessee and also that data was available. The DRP however rejected the company on the basis that the reserves and surplus and borrowings of the company were substantial as compared to its share capital and that therefore, its financials were unreliable. It also held that the functions of the company are not comparable to the assessee. 87. The ld. AR submitted that the aforesaid conclusions of the DRP are erroneous inasmuch as the mere fact that the reserves and surplus and borrowings of the company are substantial does not indicate that the financials of the company are unreliable. The functions of the company as evident from the annual report are software development services and the company earns its entire revenues from software development activity alone. Although the DRP lists out various activities as being performed by the company, the same are not evident from the annual report. In any event, the services listed out are in the nature of software development services and therefore, the conclusion that the company is not functionally comparable is erroneous. Detailed submissions in this regard are at pag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ientific method, following its earlier directions for the AY 2011-12. However it directed the AO to allow the actual expenses of Rs. 2,62,34,907/- on warranty incurred during the assessment year and has accordingly disposed of the objections raised by the Appellant. 95. The ld. AR submitted that it supplies dashboard sensors and other allied auto components to various automotive manufacturers like TVS, Hyundai, Tata, etc. The Appellant provides warranty of 24 months on its products to the customers. The Appellant creates two kinds of provision for warranty, they are: a. General Provision for warranty - The assessee creates general provision for warranty on a scientific basis towards the expected liability that could arise during such warranty period. The Appellant creates provision for warranty on the percentage of sale for each product. The quality department based on past experience and historical trend of the performance of each product arrives at a percentage based on which provision for warranty is created. b. Additional provision for warranty - Bearing in mind the nature of industry of that of automobile components manufacturer, the assessee needs to create additional pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arrived at. This percentage is applied for the purpose of creating provision against sales of each month. Thus after following the said method, the company has created the provision for general warranty. The summary of the provision for warranty is available at pages 2294-2409 of the paperbook. 100. The difference between the provision amount and the utilization amount is not the benchmark that is required to be considered. What needs to be seen is whether the provision created is on scientific basis. It is submitted that the amount of provision is a factual outcome of the methodology followed in creating provision and utilization would be the actual expenditure incurred against the warranty claims. In the present case, the assessee has followed the scientific methodology based on which provision amount is arrived at. 101. The assessee follows the specific methodology of creating provision for warranty consistently over the years. The said methodology has been submitted before the AO during the course of assessment proceedings. It creates provision for warranty on a scientific basis. 102. Reliance is placed on the following decisions in support of the above contentions: - * R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thod was followed for making the provision for warranty and in such circumstances, the judicial pronouncements on which the reliance has been placed by the assessee including the decisions of the DRP, are not of any help to the assessee. In such circumstances, we are of the view that A.O. was justified in allowing the actual expenses of Rs.1,66,77,339/-, the above objections are accordingly rejected." 105. She submitted that the above finding of the DRP for the AY 20112012 makes it clear that the assessee was not following a scientific method. The fact narrated by the AO in the draft assessment order for the assessment year, at para-8, that the provision is not based on a scientific method and therefore the decision of the Hon'ble Supreme Court, on which reliance has been placed, is not applicable. The movement in provision for warranty account as under also makes it clear that the warrant provision is not made on a scientific basis: Amount in INR Particulars General Warranty Specific Warranty Total Opening balance 13,986,741 30,201,581 44,188,322 Odd: Provision created during the year (debited to P & L A/c) 7,664,521 70,703,390 78,367,911 Less : Actual warranty ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asses Co. Ltd. (supra) was restricted to an individual retiree. On the other hand, the case of Metal Box Co. of India Ltd. (supra) pertained to an army of employees who were due to retire in future. In that case the company had estimated its liability under two gratuity schemes and the amount of liability was deducted from the gross receipts in the profit and loss account. The company had worked out its estimated liability on actuarial valuation. It had made provision for such liability spread over to a number of years. In such a case it was held by this Court that the provision made by the assesseecompany for meeting the liability incurred by it under the gratuity scheme would be entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The same principle is laid down in the judgment of this Court in the case of Bharat Earth Movers (supra). In that case the assessee-company had formulated leave encashment scheme. It was held, following the judgment in Metal Box Co. of India Ltd.'s case (supra), that the provision made by the assessee for meeting the liability incurred under leave encashment scheme proportionat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness, has been claimed as deduction u/s. 37 of the Act. The AO disallowed the same contending it to be capital in nature and also that it is not a genuine expenditure while passing the draft order, on the contention that no evidences were submitted supporting the same. The DRP has upheld the disallowance proposed by the AO and rejected the assessee's objections in this regard. However, the DRP directed that to the extent of Rs. 26,39,28,539/-, as the same has been considered as part of the operating cost for computing the margin with respect to the manufacturing segment in the TP order, the same could not be disallowed once again u/s. 37. Pursuant to above, the AO has passed the final order as per the directions of the DRP making - a disallowance of Rs. 2,75,76,144/- (Rs. 29,15,04,683/-- Rs. 26,39,28,539/-). 111. In this regard, the Assessee submitted as follows:- Expenditure incurred is allowable under section 37 of the Act: a. Annual License Fee: 112. The assessee incurred Rs. 26,39,28,539/- towards payment of Annual License Fees to its parent company and its sister concern ("Continental Global" for short) under the following agreements: Agreement A (page no. 1125 to pag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... press deductions under sections 30 to 36 of the Act. * The expenditure should not be personal in nature. * The expenditure should be incurred wholly and exclusively for the purposes of the business or profession. iii. The annual license fee is payable for making use of licensed intellectual property and/ or technical information owned by the Continental Group. iv. Such payments are made only towards "access" to technical knowledge and not absolute transfer of technical knowledge or information. v. Such expenses were incurred by the Appellant for increasing profitability relating to products manufactured by the Appellant by applying new methods of manufacture/ technology provided under the aforementioned agreements. vi. The object of the aforementioned agreements was to obtain the benefit of technical knowledge available with the licensors, for running the business of the Appellant. vii. Further, the license fee is calculated as a percentage of sales, hence, it is recurring in nature and there is no enduring benefit derived by the Appellant in this regard. Accordingly the same should be considered as revenue in nature and should be allowed as deduction under section 37 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y intellectual property. * Agreement A - 2.1 * Agreement B - 3.1 Nature of royalty Yes. Royalty was paid based on a percentage of net sales as provided in the agreements * Agreement A - 5.1 * Agreement B - 4.1 116. It is submitted that for the above expenses, the assessee receives a wide array of assistance, services, support and guidance on a recurring basis. It can be said that these royalty payments made are commensurate to the benefits obtained by the Appellant on a year on year basis. The broad key areas of support/ assistance/ service provided by Continental global to Appellant is described below in detail:- Standard Practices: a) Continental global provides access to standard procedures, methodologies, best practices, knowledge updates, etc. relating to manufacturing process of a product. These are provided largely through software platforms used by Continental group on a standardized basis across the world. These are continuously updated and the latest versions of the same are made available through portals/tools. b) The global team works on the upgradation of current technologies and products. It also avoids parallel work of a similar kind among the group ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng software and accounting software (SAP). b) Various tools like tech.net, prod.net, log.net, camline etc. are provided to the Appellant and some of the key tools in use by the Appellant are discussed below:- Sl. No. Tool Name Tool/ platform description Benefit to 'Continental India' 1 Tech.Net It is a platform which provides access to latest technical information, standard practices, procedures, etc. Tech.Net members possess highest level of education (PHd) and provide support centrally to each location whenever a problem cannot be resolved locally. Appellant uses Tech.net (manufacturing technology network) to gain access to the technical information, standard practices and documents, and applies/ implements the same for its manufacturing process, testing process, etc. As mentioned earlier, this information and support is a catalyst for the Appellant's business. 2 Collaborative robots ("Cobot") Cobotis an advanced version of robots which focuses on safety and cost reduction. This is easy and simple to program as per the user requirement. Cobothelps the Appellant in reducing dependency on man power, suppliers of raw material. This enhances overall performance with p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce. - Provision of designs, procedures and layouts Every product that the Appellant manufactures is unique and complex. Continental global develops and shares its designs, layouts and drawings relating to products, manufacturing process, etc. with the Appellant. The requirement of the customers varies from country to country and therefore, Continental global provides customized versions of its designs, layouts and drawings to the Appellant which are best suited for the Indian market. - Training a) Continental global conducts online courses, training through video conferencing, live training workshops etc. to equip its people with updated technologies, products and solutions, and specifically focus on measures and guidelines for implementation of standards, new technology etc. These trainings are facilitated from the global experts of the Continental group. This contributes to enhanced productivity. - Validation a) Continental global validates the complete product layout/ design as submitted to it by local teams for its feasibility and then provides a "go-ahead" to the local team for its implementation. This is prepared and submitted in the form of a project matrix. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an application for additional evidence to produce snapshots of various manuals, processes, standard documents and email communications demonstrating the rendering of services under each of the heads specified above. Based on the above, it was submitted that as the present case satisfies the conditions of section 37 of the Act, the license fee paid should be allowed as revenue expenditure. b. R&DCess: 118. The R&D Cess was paid by the assessee in the course of its business activities. This being an expense of revenue in nature, the same is claimed by the assessee u/s. 37 of the Act. The findings of the AO and assessee's submissions towards the same is tabulated below:- Sl. No. Learned AO's contention Appellant's submission 1 No proper evidences furnished The Appellant had submitted the following details to the learned AO: 1. Ledger extracts of R&D expense 2. Sample invoice copies raised on Appellant by group entities 3. Copy of agreements entered into with group entities 4. List of projects for which amount was charged specifically to projects 5. Sample copy of two patents which in the name of Continental, Germany The above substantiates rendition of service, the na ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ical information that helps facilitate the manufacturing activity of the Appellant. 119. Based on the above, the ld. AR submitted that the impugned expense is revenue in nature and the same is allowable under section 37 of the Act. Without prejudice to the above, it is submitted that for the assessment years, i.e., 2009-10 and 2011-12, the similar issue has been remanded for fresh consideration by this Tribunal. Claim of the Appellant under section 35(1)(iv) of the Act 120. Notwithstanding and without prejudice to the above, even if the said expenses incurred by the Appellant for its own business are held relating to R&D and that the expenses provide enduring benefit, the claim of deduction of the Appellant must be allowed under section 35(1)(iv) of the Act. It is further submitted that DSIR approval is neither required for claim of deduction under section 35(1)(iv) nor under section 37, as DSIR approval is mandated for weighted deduction under section 35(2AB). Claim of the Appellant under section 32 of the Act 121. Notwithstanding and without prejudice to the above, even if the said expenses are held as capital in nature, the Appellant would be eligible to claim depreciatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e for entering into agreement with the AE w.e.f. 01-01-2009. (ii) As per the Agreement, the amount claimed is Royalty and therefore, we do not find any rationale in debiting such amount in profit and loss account as R&D expenses. (iii) On perusal of the balance sheet, it is also noticed by us that the sundry creditor in respect of Continental Automotive GMBH, Germany is increasing on year to year basis. (iv) On perusal of the audit report in Form 3CD, it is noticed by us that in respect of particulars of payment made to the specified persons u/s 40A(2)(b) of the Income tax Act, the amount of 10,88,25,803/- has been mentioned as payment for Research and Development/ (v) If we go by the Agreement, the amount is in the nature of Royalty paid to a non-resident hence, liable for deduction of tax at source u/s 195 of the Income tax Act. However, there is no evidence to support that the tax has been deducted at source on payment of such Royalty. (vi) In the TP study, the above amounts has not been shown separately as payment of Royalty, similarly, in audit report in Form 3CEB also, the amount has not been shown as paid towards Royalty. (vii) Except the copy of the agreement, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he margin with respect to manufacturing segment and in the TP adjustment in that segment works out to more than the above expenses, the DRP was of the view that the TP adjustment includes the above amount and therefore the separate disallowance under section 37(1) amounts to disallowing the same amount twice. In such circumstances, the DRP observed that unless the adjustment made under section 92CA(3) of the Act, in respect of manufacturing segment, becomes less than Rs.26,39,28,539, it is not appropriate to make a separate disallowance under section 37(1) or under section 40(a)(i) of the Act, considering the fact that the above amount represents international transactions which was evaluated under CUP by the TPO and also under TNMM by aggregating the said transaction to the manufacturing segment. If at any subsequent stage, either the adjustment under TNMM is reduced to less than the above payments, then the disallowance under section 37(1) and alternatively under section 40(a)(i) has to be revived as the assessee failed to produce any evidence to establish that tax was deducted at source and paid within the time limit allowed under proviso applicable to sub-clause (i) of clause ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts order in IT(TP)A No.165 and 254/Bang/2014 dated 28.09.2017 in the assessee's own case for Assessment Year 2009-10 had remanded this issue back to the file of the AO for fresh examination and adjudication. The grounds raised by the assessee in this regard before the Tribunal for Assessment Year 2009-10 at 8 to 8B at page 3 of the order of the Co-ordinate Bench are extracted hereunder: "8. Disallowance of Research and Development (R&D) Expenditure-- Rs. 33,897,837 8.A The learned AO erred in concluding approval under section 35(2AB) is mandatory for claiming expenses in the nature of annual license fee, testing charges and engineering services charges which have been merely grouped as R&D Expenditure. The learned AO ought to have appreciated that these expenditure are towards operating activities of the Appellant and do not provide any enduring benefits. 8.B Notwithstanding and without prejudice to the above, even if the said expenditure are held to give enduring benefit on the argument that the same pertain to research & development, the expenditure should be allowed as a deduction under section 35(1) of the Act." 7.2.3 The Co-ordinate Bench of the Tribunal in its ord ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
