M/S. CONTINENTAL AUTOMOTIVE COMPONENTS INDIA PRIVATE LIMITED,BENGALURU vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-2(1)(1), BANGALORE
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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI GEORGE GEORGE K. & Ms. PADMAVATHY S
per actuals, after considering the decisions rendered in this order on the exclusion/inclusion of comparable companies out of/into the final set of comparables. The TPO/ AO are accordingly directed.
The other grounds raised in its appeal in relation to its international transaction of provision of SWD services are not pressed at this stage. However, the Assessee seeks liberty to urge the said grounds in any future proceeding, appellate or otherwise, and in these proceedings at a future point in time. The liberty prayed for is allowed. The TPO/AO is directed to compute the ALP in the SWD services segment, after due opportunity of being heard to the Assessee afforded.
CORPORATE TAX GROUNDS
Ground Nos. 35-43 is with regard to disallowance of provision for warranty. During the year, the Assessee had created a provision for warranty amounting to Rs. 8,46,53,034/- which was claimed as deduction. The AO disallowed the provision for warranty contending the same to be contingent liability/ created on estimate basis. The DRP upheld the disallowance proposed by the learned AO and rejected the Assessee’s objections in this regard. The AO passed the final order disallowing the closing balance of 3,43,62,724/-.
It is submitted by the ld AR that the Assessee is primarily engaged in the business of manufacturing and trading of instrumentation products, clusters, sensors and other allied components for the automobile industry. The Assessee provides warranty of 24
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months on its products to the customers. During the year, the Assessee had closing liability towards provision for warranty amounting to Rs. 34,362,764. The Assessee 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 Assessee 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 provision for warranty based on the circumstances and specific cases. During the year under consideration, there was no additional provision for warranty created. The movement in provision for warranty as accounted for by the Assessee for the year under consideration is as under:
Particulars Amount in Rs. Opening balance 4,01,12,831/- Add: Provision created during the year (debited 8,46,53,034/- to P & L A/c) Less : Actual warranty claims (9,04,03,141/-) Closing balance 3,43,62,724/- 122. It is pointed out by the ld AR that it can be seen from the movement of provision for warranty tabulated above, the actual utilization (Rs. 9,04,03,141/-) during the year under consideration is
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more than the provision created (Rs. 8,46,53,034/-). As such the net impact on account of provision for warranty to the profit and loss results is negative. Accordingly, the ld AR submitted that the utilization of the expense is on the higher side compared to the provision created, which itself indicates that the methodology followed by the Assessee is scientific. The ld AR further submitted that an analysis of the warranty provision over a period of five years and the same is tabulated below:
AY Opening Actual debit Actual Balance balance to P&L expenditure 2012-13 4,41,87,200 7,83,67,911 2,62,34,907 9,63,20,204 2013-14 9,63,20,204 1,66,55,739 5,88,40,832 5,41,35,111 2014-15 5,41,35,111 94,97,052 2,61,22,163 3,75,10,000 2015-16 3,75,12,432 4,10,30,636 3,84,30,238 4,01,12,830 2016-17 4,01,12,831 8,46,53,034 9,04,03,141 3,43,62,724 Total 23,02,04,372 24,00,31,281
It is contended by the ld AR that it can observed from the above table that the utilization of the warranty provision exceeds the provision created over a five-year period which indicates that the methodology followed by the Assessee is scientific.
It is pointed out that in the draft assessment order, the AO had made several observations which the Assessee had clarified before the DRP as under:
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Sl. AO’s contention Assessee’s submission Reference No. 1 There is a huge The difference between the difference provision amount and the between utilization amount is not the provision amount benchmark that is required to be and utilization considered. What needs to be seen is whether the provision created is on scientific basis. 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. Further, utilization amount represents expense incurred on actual claims received by the Assessee. Further, it is relevant to note that the utilization of the warranty provision exceeds the provision created in the past years, which indicates that the methodology followed by the Assessee is scientific. 2 Provision is made The Assessee had submitted paper book ref – on estimate basis/ following details to the AO: adhoc basis Page No.1569- • Ledger extract for actual 1574 warranty expenses incurred by the Assessee along with the supporting documents on sample basis • Summary of provision Page No.1553- created for warranty 1555 The above evidences and the methodology of creating such provision substantiates that the
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warranty policy adopted by the Assessee is on scientific basis and not adhoc basis. 3 Actual warranty The AO failed to appreciate that claims debited to the Assessee adjusts actual profit and loss warranty claims against account/ No provision in the provision separate ledger account, a separate ledger is maintained for the said purpose. The AO ought to have appreciated the fact that the Assessee debits the actual warranty claims to provision for warranty ledger account and not to the profit and loss account.
Accordingly it is submitted that 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. The Assessee submits that it creates provision for warranty on a scientific basis. The ld AR drew our attention to the decision of coordinate bench of this Hon’ble Tribunal in the Assessee’s own case for the assessment year 2014-15, on identical facts, has held that the provision for warranty is to be allowed as a deduction as the provision created satisfied all the requirements for claiming the provision as a liability. The ld AR further, submitted that this Hon’ble Tribunal in the Assessee’s own case for the assessment year 2010-11 has rendered a finding that the Assessee is following scientific basis of creating the provision and had remanded the matter for verification of details by the Assessing
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Officer. Subsequently, the Assessing Officer passed an order giving effect to this Hon’ble Tribunal’s order, accepting the claim made by the Assessee.
Notwithstanding and without prejudice to the above the ld AR submitted that AO cannot disallow closing balance of the provision for warranty as the same is not debited to the profit and loss account. The AO ought to have appreciated that during the year the actual utilization is more than provision created and as such the net impact on account of provision for warranty to the profit and loss account is negative.
The learned DR relied on the order of the DRP
We heard the rival submissions and perused the material on record. We notice that the coordinate bench in assessee’s own case for AY 2014-15, has considered the identical issue and held that –
We have carefully considered the submissions and are of the view that provision for warranty created is based on past experience and historical trend of each product and at a percentage. The claim made by the Assessee that the method followed for creating provision for anticipated liability on account of warranty stands vindicated by the fact that the actual liability on account of warranty expenses is always on the higher side. The reasons given by the DRP for not accepting the claim of the Assessee is that the provision is created as a percentage of sale, ignoring the fact that past experience is also the basis for creation of provision for warranty. We are therefore of the view that the provision for warranty has to be allowed as a deduction, as the provision created satisfies the requirements for claiming provision as a liability, as laid down in the judicial precedents
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referred to above. We hold and order accordingly and allow the relevant ground of appeal of the Assessee. 129. Since there no change in the current year with regard to the provisions for warranty and the facts being identical, we respectfully follow the above decision of the coordinate bench and hold that warranty has to be allowed as a deduction. It is ordered accordingly.
Ground Nos. 44-56 relate to disallowance of royalty of Rs. Rs.29,14,50,952/-. The Assessee incurred Rs.29,14,50,952/- towards payment of royalty by entering into various agreements with the group companies i.e. Continental Automotive GmbH, Germany, Continental Automotive France SAS, France, Continental Automotive Systems Inc., USA, Conti Temic microelectronic GmbH, Germany and Continental Teves AG & Co. oHG, Germany. The Compensation for the aforementioned agreements has been agreed to be paid by the Assessee as royalty in percentage terms of net sales on account of use of intellectual property generated from basic R & D and prescribed percentage on net sales on account of use of intellectual property generated from old application R & D. Further, separate compensation towards the license has been agreed to be paid by the Assessee as royalty computed as percentage of net sales of sensoric products per year. The AO disallowed the claim treating the same as R&D expenditure giving enduring benefit to the assessee and accordingly capital in nature. The AO held that the assessee has not produced proper evidence of the nature of expenditure. The DRP upheld the
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treatment of the impugned amount as capital expenditure but directed the AO to allow depreciation u/s.32 on the same by placing reliance on the decision of the Supreme Court in the case of Honda Siel Cars India Limited (2019) 101 taxman 222(SC). Aggrieved by the final order passed by the AO pursuant to the directions of the DRP the assessee is in appeal before the Tribunal
The ld AR submitted that that the royalty incurred by was for the use of technology of the Continental Group for manufacturing and sales of the products. Such expenditure should be allowed under section 37(1) of the Act based on following submission:
i. Section 37 of the Act is a residual clause for claiming deduction for any expenditure incurred for the purposes of the business. ii. For the purpose of claiming deduction under section 37 of the Act, the following conditions should be fulfilled: The expenditure must be revenue in nature and should not • be covered by any express 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. Such payments are made only towards “access” to technical knowledge and not absolute transfer of technical knowledge or information. iv. Such expenses were incurred by the Assessee for increasing profitability relating to products manufactured by the Assessee by applying new methods of manufacture/ technology provided under the aforementioned agreements.
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v. The object of the aforementioned agreements was to obtain the benefit of technical knowledge available with the licensors, for running the business of the Assessee. vi. Further, the royalty is payable by the Assessee for making use of licensed intellectual property and/ or technical information owned by the Continental Group. In this regard, Continental group provides wide array of assistance, services, support and guidance to the Assesseeon recurring basis. It can be said that the royalty expense incurred by the Assesseeis commensurate to the benefits obtained by the Assesseeon a year on year basis. The keyareas of support/ assistance/ service provided by Continental group are as below: a) Standard practices; b) Access to various tools/ platforms; c) Assistance in sourcing; d) Provision of design, procedure and layouts; e) Training; f) Validation; g) Testing; h) Problem resolution; and i) Other assistances. The aforesaid technical service, support and guidance received from Continental group is essential for the uninterrupted conduct of Assessee’s day-to-day business activities. Continental group invests their efforts for providing the said services on a continuous basis vii. Further, the royalty is calculated as a percentage of sales, hence, it is recurring in nature and there is no enduring benefit derived by the Assessee in this regard. Accordingly the same should be considered as revenue in nature and should be allowed as deduction under section 37(1) of the Act, since it satisfies all the aforementioned conditions. viii. In this regard, the Assessee also wishes to place reliance on the following decisions:
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Hon'ble Karnataka High Court decision in the case of CIT • v. Luwa India Ltd [2012] 18 taxmann.com 365 (Kar.) Samsung India Electronics Private v. ACIT [I.T.A. No. • 5316/Del/2011] Kanpur Cigarettes (P.) Ltd. v. CIT147 Taxman 428 • (Allahabad High Court) • CIT v. Kirloskar Tractors Ltd [1998] 231 ITR 849 (Bombay HC) • Alembic Chemical Works Co. Ltd. v. CIT[1989] 43 Taxman 312 (SC) J.K. Synthetics Ltd. v. CIT[2009] 176 Taxman 355 (Delhi • High Court) DCIT v. Honda SIEL Power Products Ltd I.T.A .No. • 1579/DEL/2017 (A.Y 2012-13) & S. A No. 217/Del/2017 in ITA No. 1579/Del/2017 132. The ld AR submitted that the ratio laid down by these judicial pronouncements is that that there are certain conditions to be satisfied for the payment to be treated as revenue expenditure and in this regard drew our attention to the various clauses of the agreement entered into by the assessee which is tabulated below –
Factors under Whether the conditions are Clause reference in the consideration satisfied? Agreements A and B • Agreement A - 6.1.2 License period Yes. All the licenses are • Agreement B - 7.1 and and termination granted for a limited period. The agreements can be 7.2 terminated at the discretion of both parties. • Agreement A - 2.2 Restriction on Yes. The Assessee can sub- • Agreement B - 3.1 creation of license only on receipt of prior further rights/ written approval from the assignment Licensor. • Agreement A - 8 Confidentiality Yes. The Assessee is obligated • Agreement B - 6.1 to to hold in confidence all the information provided under the 6.5 agreement.
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Factors under Whether the conditions are Clause reference in the consideration satisfied? Agreements A and B • Agreement A - 2.1 Degree of Yes. The scope of the license • Agreement B - 3.1 transfer is only to grant right to use licensed intellectual property. There is no transfer of absolute ownership of any intellectual property. • Agreement A - 5.1 Nature of royalty Yes. Royalty was paid based • Agreement B - 4.1 on a percentage of net sales as provided in the agreements
The ld AR further submitted that for the above expenses, the Assessee receives a wide array of assistance, services, support and guidance on a recurring basis whereby it can be said that these royalty payments made are commensurate to the benefits obtained by the Assessee on a year on year basis. The ld AR also submitted a detailed note on the broad key areas of support/ assistance/ service provided by Continental global to Assessee and also counter arguments with regard to each of the contentions of the AO/DRP. The same has been taken on record for the purpose of adjudication.
We heard both the parties and perused the materials on record. We notice that the Hon'ble Karnataka High Court in the case of CIT v. Luwa India Ltd (supra) has considered a similar issue and held that –
It is clear that though certain decisions have been relied on to determine the question as to whether the expenditure incurred is capital or revenue, there is no universal formula that is laid down and finding would depend upon the facts of the given case and depend upon the terms of the agreement, method of payment and the valuation upon which payment is made and also on other material facts of the case. In the present case, the ITAT having
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regard to the contents of the agreement entered into by the assessee with M/s. LUWA Switzerland has held that the licence that was granted does not confer any proprietary right in obtaining technical know-how, the licence is granted as per the agreement subject to payment of royalty to make use of know- how and technology. The royalty payable is depending upon the sales made and export. The said finding is on the question of fact and cannot at all be said to be perverse or arbitrary. As the facts in this case is identical to the facts of the case in Ciba of India Ltd. case cited above and also the decision in I.A.E.C. (Pumps) Ltd. (supra) cited above. There is no merit in the contention of learned counsel appearing for the Assessee that since know-how and technology granted by the licence and the patents is of enduring nature, the same would constitute capital expenditure as the payment made is on the basis of sales and export made by the assessee. The mere fact that the said know-how and patent has been acquired even before commencement of production in this case would not in any way material itself having regard to the agreement and payment of royally as referred to above and therefore, finding of the ITAT that the expenditure made towards royalty in a sum of Rs. 28,07,950/- is revenue expenditure is justified and we answer the first substantial question of law against the revenue and in favour of the assessee. 135. The ratio laid down by the Hon’ble High Court is that the payment of royalty to make use of know-how and technology which is also depending upon the sales made and export is to be treated as a revenue expenditure and should be allowed as a deduction accordingly. In assessee’s case it is noticed that the assessee has entered into agreements with various entities in the Continental group for making use of licensed intellectual property and/ or technical information owned by the Continental Group and to obtain the benefit of technical knowledge available with the licensors, for running the business of the Assessee. It is also submitted by the ld AR that the royalty is calculated
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as a percentage of sales, hence, it is recurring in nature and there is no enduring benefit derived by the Assessee in this regard. We also notice that the AO has treated the expenditure as capital in nature for the reason that the assessee has not produced proper evidence of the nature of expenditure and the nomenclature used is R&D expenses. We further notice that the various clauses of the agreement supporting the claim of the assessee that the payment made is towards royalty have not been examined by the AO though it is submitted by the ld AR that these agreements were submitted before the lower authorities. In the light of this discussion we are of the considered view that the issue should be remitted back to the AO to examine the issue afresh based on the agreements and other evidences submitted by the assessee. We also direct the AO to keep in mind the ratio laid down by the Hon’ble Jurisdictional High Court in the case of Luwa India Ltd.(Supra) while examining the case facts in assessee’s case and decide accordingly. Needless to say that the assessee be given a reasonable opportunity of being heard. It is ordered accordingly.
The assessee while contending this issue raised grounds with regard to allowability of the impugned expenditure u/s. 35(1)(iv) and that there is a double disallowance. In view of our decision on the allowability of impugned expenditure u/s.37, these grounds have become academic not warranting separate adjudication.
Ground No.57 is consequential not warranting separate adjudication.
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In the result, the appeal of the assessee is partly allowed.
Pronounced in the open court on this 06th day of February, 2023.
Sd/- Sd/-
( GEORGE GEORGE K. ) ( PADMAVATHY S. ) JUDICIAL MEMBER ACCOUNTANT MEMBER
Bangalore, Dated, the 06th February, 2023. /Desai S Murthy /
Copy to:
Assessee 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. By order
Assistant Registrar ITAT, Bangalore.
