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TMI Blog2022 (3) TMI 1455X X X X Extracts X X X X X X X X Extracts X X X X ..... equity and natural justice and are contrary to the facts and circumstances of the present case. 2. Transfer pricing adjustment in the Manufacturing segment of INR 10,19177,372 2.1. The Hon'ble DRP and learned AO / TPO have erred in law and on facts in making transfer pricing ("TP") adjustment of INR 10,19,77,372 to the returned loss 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. 2.2. Rejection of internal comparable uncontrolled price selected as the most appropriate method by the Appellant 2.2.1. The Hon'ble DRP and learned AO / TPO have erred in law by rejecting the application of Internal Comparable Uncontrolled Price ("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. 2.2.2. The Hon'ble DRP and learned AO / TPO have erred in upholding the learned TPO's stand that average of the comparable uncontrolled transaction prices which are similar comparables to each other cannot be taken as the ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and learned AO / TPO have erred in law and on facts by adopting the TNMM as the MAM for benchmarking the international transaction of import of raw materials in the manufacturing segment. 2.4. Fresh comparability analysis undertaken by the learned TPO 2.4.1. The Hon'ble DRP and learned AO / TPO have erred in law by conducting a fresh search for comparable companies and by rejecting the benchmarking process carried out by the Appellant as per the provisions of the Act, without giving adequate reasons for the rejection. 2.4.2. The Hon'ble DRP and learned AO / TPO have erred in law in adopting the following filters for conducting TP analysis, without appreciating the TP documentation prepared by the Appellant: * Rejection of companies having different financial year ending (other than March 31, 2013) or data of the company does not fall within the 12 month-period of April 1, 2012 to March 31, 2013. 2.4.3. The Hon'ble DRP has erred in law and on facts in not providing detailed reasons for rejecting the contentions of the Appellant for exclusion of the TPO's comparable companies even though detailed submissions were filed by the Appellant in this regard. 2.4.4. The learned A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... justment in relation to Advertising, Marketing and Promotion expenditure of INR 82,05,25,509 3.1 AMP expenditure not an international transaction 3.1.1 The Hon'ble DRP and 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 expenditure on the directions of the AE. 3.1.2 The Hon'ble DRP and learned AO / TPO have erred in law and on facts by taking suo-moto cognizance of alleged international transaction in relation to AMP expenditure, alleging that the Appellant is building marketing intangible for its AE. 3.1.3 The Hon'ble DRP and learned AO / TPO have erred in law and on facts, in making TP adjustment of INR 82,05,25,509 to the returned loss 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 Rules. 3.1.4 The Hon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 March 31, 2013. 3.1.11 The Hon'ble DRP and 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. 3.1.12 The Hon'ble DRP and learned AO / TPO have erred in law and on facts by disregarding judicial pronouncements in undertaking TP adjustments in relation to AMP. 3.1.13 The Hon'ble DRP and learned AO / TPO have evaluated the reasonableness of such expenses, which should not be judged only on the subjective standards but from the point of view of commercial expediency. 3.1.14 The Hon'ble DRP and learned AO / TPO have erred in not carrying out the determination of ALP as required under section 92C of the Act read with rule 10D of the Income-tax Rules, 1962. 3.2 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity 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 Delhi Bench of Hon'ble ITAT in case of Luxottica India Eyewear Pvt Ltd Vs. ACIT1 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-à-vis the AMP expenditure incurred by The Appellant. 3.2.8 The Hon'ble DRP and learned AO / TPO have erred in law and on facts by characterizing the incurrence of AMP expense as a provision of services by the Appellant to its AE requiring a mark-up. 3.2.9 The Hon'ble DRP and 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'. 3.2.10 Notwithstanding and without prejudice to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO have erred in law and on facts by not granting the benefit of quantitative adjustments while computing the TP adjustment for the alleged excessive AMP expenditure incurred by the Appellant. 3.2.16 The Hon'ble DRP and learned AO / TPO have erred in not granting appropriate favourable economic adjustments (including the working capital adjustment) when assessing the arm's length nature of alleged international transaction of the Appellant. 3.2.17 The Hon'ble DRP and 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. 4. Disallowance of provision for warranty 4.1 The Honorable DRP and the learned AO have erred in law in arbitrarily disallowing the provision for warranty amounting to INR 13,40,69,800 claimed as a deduction by the Appellant. 4.2 The Honorable DRP and the learned AO have erred in law by not following the order of the Honourable ITAT in the Appellant's own case for the AY 2006-07, AY 2007-08, AY 2010-11 and AY 2011-12, wherein it was held that the provision for warranty has been created on a scientific basis and that the same should ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion for warranty should not be added back while re-computing book profits under section 115JB of the Act. 6.1.3 The Honorable DRP and the learned AO have erred in law and on facts in holding that the warranty provision of INR 13,40,69,800 is an unascertained liability and therefore, not appreciating that the warranty provision is created on a scientific basis after considering technical estimates which is consistently followed by the Appellant year on year. 6.2 Addition of provision for leave encashment to the book profits 6.2.1 The Honorable DRP and the learned AO have erred in adding back the provision for leave encashment created during the relevant AY amounting to INR 8,61,790 to the book profit of the Appellant. 6.2.2 The Honorable DRP and the learned AO have erred in law by not following the order of the Honorable ITAT in the Appellant's own case for the AY 2010-11 and AY 2011-12, wherein it was held that the provision for leave encashment is not an unascertained liability and therefore, is not required to be added back to the book profits under section 115JB of the Act. 6.2.3 The Honorable DRP and the learned AO have erred in law and on facts in concluding that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee chose Comparable Uncontrolled Price (CUP) as the Most Appropriate Method (MAM) for determining ALP. Assessee compared the price paid for import of parts and components from unrelated persons with the price paid for import of parts and components to the AE. In its Transfer Pricing 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 assessee characterized itself as a "full- fledged manufacturer" for its manufacturing activity. 2.4 The Ld.TPO did not accept the TP analysis by assessee for the reasons given in the show cause notice dated 20.09.2016. He rejected the CUP method adopted by the assessee to its Manufacturing Segment and applied the TNMM as the MAM and determined ALP which resulted in an adjustment of Rs.10,19,77,372/-. 2.5 The Ld.TPO observed that assessee 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 campaigning, depicting features of new prod ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nder consideration the assessee imported certain parts and components from its Associated enterprises ("AEs") for purpose of manufacturing of Personal Computers (PCs). The transaction of import of parts and components was an international transaction and therefore income from such international transaction was to be determined having regard to Arm's Length Price (ALP) as laid down in Section 92 of the Act. The Appellant also imported parts and components from third parties. The methodology adopted by the Appellant 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 (Rs.) ALP as determined by the Appellant (Rs.) Remarks Import of raw material CUP 60,51,95,623 59,56,75,480 suo-moto adjustment of Rs.95,20,143/- in the return of Income. The Ld.AR submitted that the assessee during the year under consideration, imported 408 different varieties of products from its AEs which can be identified on the basis of a distinctive code. Out of 408 products, 180 products were purchased from its AEs exclusively while the rest 228 were purchased from AEs as well as from unrelated thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... serving that in CUP method, strict comparability is required and such comparability is not possible in the case of the assessee. The DRP also upheld application of TNMM as MAM and methodology adopted to determine ALP under the TNMM by the TPO. On receipt of the DRP order the Ld.AO passed the final assessment order making the adition in the hands of the assessee. Against the final assessment order, the assessee raised the issue before this Tribunal. At the outset the Ld.AR submitted that this issue has been considered by Coordinate Bench of this Tribunal in assessee's own case in following assessment years. * IT(TP)A No. 582/Bang/2015 for A.Y. 2006-07 by order dated 30.05.2016 * IT(TP)A Nos. 74 & 88/Bang/2014 for A.Y. 2009-10 by order dated 06.07.2018 * IT(TP)A Nos. 511, 580 & 581/Bang/2015 & 1307/Bang/2011 for A.Ys. 2007-08 & 2010-11 by order dated 31.03.2017 * IT(TP)A No. 373/Bang/2016 for A.Y. 2011-12 by order dated 21.10.2016 * IT(TP)A No. 2444/Bang/2019 for A.Y. 2015-16 by order dated 06.03.2020 We refer to the order passed by this Tribunal for A.Y. 2015-16 which is the recent most order wherein this Tribunal decided this issue on identical facts in assessee's own ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see stands allowed for statistical purposes. As we have already decided the above grounds, Ground no.2.7 becomes general in nature, that do not require adjudication. Ground no.3 relates to the treatment of AMP expenses pertaining to trading segment as an international transaction and determining the ALP in respect of the same. The submission of the Ld.AR is that CUP should be accepted as the MAM. He has tabulated the objections to each of the reasons put forth by the Ld.TPO/DRP for the rejection of CUP as the MAM as under: Sl No Reasons for rejection of CUP as the MAM Assessees contention 1. Non-availability of reliable data in order to compare the degree of comparability between the international transaction and uncontrolled transactions The Assessee imports raw materials from both AEs as well as unrelated vendors for the manufacture of PCs. The revenue did not consider the fact that the parts, being components have a unique identity and bear serial numbers or codes by which they are known. The Assessee documented the analyses in respect of the comparison of the prices for all the products that have been imported from its AE. Hence the reasons provided in the rejection o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is not subjective; * The ruling of the ITAT was based on the fact that the taxpayer had received income from services rendered to its AE. In the present case, the Assessee's transactions pertain to expenses that have been incurred; and * Lastly, in the case relied upon by learned TPO, the taxpayer relied upon external CUP whereas the Assessee has relied upon internal CUP in benchmarking its transaction. 4. There is no publicly available information on prices charged in independent transactions of similar or identical nature, so external CUP cannot be applied. For the application of the CUP method, the primary condition to be satisfied is that there should exist a transaction for an identical product between two unrelated parties. In a wholesale business scenario, for obvious reasons, the transaction prices of products are not publicly available since such prices are negotiated closely between the parties and would be binding only on the parties. However, where the transaction involves the Assessee himself the information would be available and would constitute the comparable price for the transaction. In the instant case, the Assessee has transacted for identical products an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction..." (Emphasis supplied) Based on the above observations in assessee's own case for A.Y. 2015-16 (supra), this Tribunal recorded a finding as under: "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 down by the Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communications India P. Ltd. (supra), incurring of AMP expenses cannot be treated as international transaction and consequently determination of ALP would not arise for consideratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t proceedings, the Ld.AO observed that assessee created provision of warranty. The assessee was called upon by the Ld.AO to explain as to why the provision should not be disallowed. In response, vide submission dated 6/12/2016 and 7/12/2016, the assessee submitted that, the provision for warranty of Rs.13,40,69,800/- was created based on the total number of warranty obligations outstanding as of 31/03/2013. It was also submitted that, the methodology of arriving at provision and the computation of provision for warranty based on such methodology and as per the principles laid down by the Hon'ble Supreme Court in the case of Rotork Controls India Pvt. Ltd. vs. CIT, reported in [2009] 180 Taxman 422/314 ITR 62 (SC) was also submitted. Assessee also relied on the decision of coordinate bench of this Tribunal in assessee's own case for AY 2006-07 and AY 2011-12, wherein it was held that the assessee has followed a scientific methodology for creation of provision for warranty was also submitted. The Ld.AO however rejected the submissions of assessee and denied the claim by observing that the provision for warranty has been disclosed as a contingent liability under AS 29, by assessee. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat 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 follow AS-I and principles of prudence stipulated in such AS-I required provisioning for all known liabilities even if it could not be determined with certainty, but was made based on available data. We therefore delete the addition made by the AO disallowing the provision for warranty." AY 2007-08(supra) Placing the reliance on the assessee's own case for the AY 201112 the coordinate bench of this Tribunal concluded as under: "5. Thus the Tribunal has taken a consistent view on this issue. The Id. Senior Counsel has also relied upon the decision dt. 10.4.2013 of Hon'ble jurisdictional High court in the case of CIT Vs. IBM India Limited for the Assessment Year 1998-99 wherein the Hon'ble Supreme Court has held that the conditions as stipulated by the Hon'ble Supreme Cour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sion dated 1/12/2016, assessee submitted that the as per the leave encashment policy, every employee is entitled to a fixed number of leaves every year and the employees are entitled to en-cash the available balance of leaves, subject to certain conditions, at the time of resignation/ retirement. It was submitted that in order to provide for such leave encashment expenses, the assessee creates provision for leave encashment every year based on the salary earned by the employees and their unutilized leave balance. In such manner, it was submitted that the net provision for leave encashment created during the year amounted to Rs.8,61,790/-. It was submitted that the provision for has been created as per the provisions of AS 15, which is required to be followed by the Company as per section 133 of the Companies Act, 2013. The Ld.AO rejected the submission of assessee and held that provision for leave encashment is being unascertained liability was liable to be disallowed under section 43B of the Act. Aggrieved by the order of the Ld.AO, appeal was filed objection before the DRP who upheld the view of the Ld.AO. The Ld.AO disallowed the entire provision while passeing the final asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt liability, and that, the same ought not to be disallowed while computing income under normal provisions of the Act. The relevant extract of the order is as below: AY 2011-12(supra) 11.1 Before us, learned counsel for the assessee submitted that provision for gratuity was allowed as deduction in the proceedings u/s 154 of the Act and therefore, not pressed. As regards provision for leave encashment, he submitted that it is not a contingent provision and is allowable as deduction in view of the decision of the Hon'ble Supreme Court in the case of Bharat Earth Movers vs. CIT (supra). As regards provision for warranty, learned counsel for the assessee submitted that since same is allowable as business expenditure, it cannot be added to book profits. 11.2 On the other hand, ld.CIT(DR) placed reliance on the orders of the lower authorities. 12. The only issue relates to addition of provision for leave encashment and the provision for warranty expenditure added to book profits while computing tax liability u/s 115JB of the Act. As regards provision for warranty expenditure, we had already held that it is not a contingent liability and hence is allowable as deduction. Therefore, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed counsel for the parties and having perused documents on record, we notice that CIT(A) as well as the Tribunal both noted that such provision for payment of gratuity was made on the basis of actuarial valuation method to this aspect. The revenue has not been able to make any dispute. If we proceed on that basis, law to our mind, seems fairly well settled. Bombay High Court in case of Echjay Forgings (P.) Ltd (supra) in the context of similar provisions made in Section 115JB of the Act examined whether the provision of gratuity liability of a company is required to added back to its book profit. In this context, it was held that the assessee had made the provision for gratuity on the basis of actuarial calculations. He, therefore, cannot be said that the provision for gratuity is not ascertained liability. 18. In case of Bharat Earth Movers v. CIT [2000] 245 ITR 428/112 Taxman 61 the Apex Court held that the amounts set apart by an assessee to meet its liability on account of leave encashment of employees is not a contingent liability. It was observed that what should be certain is the incurring of the liability which should also be estimated with reasonable certainty though the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stical purposes. Ground NO. 6 - ADJUSTMENTS TO BOOK PROFIT UNDER SECTION 115JB OF THE ACT The Ld.AO treated the provision for warranty and provision for leave encashment as an 'unascertained liability' and added the same to book profits under section 115JB of the Act. The DRP has agreed with the contention of the AO and rejected the objections. In the preceding paras, following the ration laid down by Hon'ble Supreme Court in case of Rotork Control(supra) we have held that the provision for warranty cannot be treated as unascertained liability. In respect of provision of leave encashment, this Tribunal in assessee's own case for AY 2011-12(supra) has observed as under: "Respectfully following the above decision, we hold that provision for leave encashment need not to be added back to book profits for the purpose of determining tax liability u/s 115JB of the Act." Under such circumstances we do not find any merit in the manner in which the book profits for purposes of section 115JB has been computed. Accordingly we direct the Ld.AO to exclude the two items from the book profits for purpose of computing tax liability under section 115JB of the Act. Accordingly Grou ..... X X X X Extracts X X X X X X X X Extracts X X X X
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