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Income Tax Appellate Tribunal, DELHI BENCH “I-1”: NEW DELHI
Before: SHRI R.K. PANDA & MS. ASTHA CHANDRA
The appeal of the assessee is directed against the order of Additional/Joint/Deputy/ACIT/ITO, National E-Assessment Centre, Delhi (“AO”) under section 143(3) read with section 144C of the Act pertaining to AY 2017-18.
The assessee has raised the following grounds of appeal:- “Pertaining to Transfer Pricing Matters: Adjustment Rs. 1,56,78,332 1.1. On the facts and in the circumstances of the case and in law, the Learned Dispute Resolution Panel (‘Ld. DRP’), the Learned Transfer Pricing Officer (‘Ld. TPO’) and the Learned AO (collectively referred as “the Revenue”) erred in making an adjustment of Rs. 1,56,78,332 to the total income of the appellant on account of the difference in the arm’s length price (‘ALP’) of its international related party transactions under the provisions of Section 92CA(4) of the Act. 1.2. On the facts and in the circumstances of the case and in law, the AO/TPO/DRP has grossly erred in disallowing the mark-up portion charged by the associated enterprises (“AEs”) without providing any cogent reason thereof. In doing so, the Revenue erred in: 1.2.1. Disregarding the fact that based on the economic and commercial circumstances, no independent third party would agree to provide such services without keeping an arm’s length profit element over and above cost of services. 1.2.2. Disregarding the comprehensive benchmarking analysis undertaken by the appellant, without demonstrating the inadequacy or infirmity in the analysis so conducted by the appellant. 1.2.3. Disregarding the corroborative internal Comparable Uncontrolled Price analysis furnished by the appellant in relation to availing of supervision services. 1.2.4. Adopting a contradictory view with respect to availing of supervision services while accepting similarly priced services that the appellant provided to its AEs. 1.3. On the facts and in the circumstances of the case and in law, the Revenue erred in not appreciating that the pricing of such services including the mark-up paid thereof has been accepted by the Hon’ble ITAT and by the Ld. TPO/ Ld. AO in the appellant’s own case for the 2
past years and there being no change in the facts and circumstances of the case in AY 2017-18 vis-a-vis the aforesaid years. 1.4. On the facts and in the circumstances of the case and in law, the AO/TPO/DRP have erred in not allowing the benefit of (+/-) 3% as provided in the proviso to Section 92C(2) of the Act, while determining the arm’s length price of the international transactions of the appellant. 1.5. On the facts and in the circumstances of the case and in law, the AO/TPO/DRP have erred in incorrectly considering the mark-up amount as Rs. 1,56,78,332 instead of actual mark-up of Rs. 98,11,305 paid by the appellant on such services. In doing so, the Revenue erred in disregarding all documentary evidences furnished by the appellant in support of calculation of correct mark-up amount. Pertaining to Corporate Tax Matters: Adjustment Rs. 11,11,70,277 2.1. On the facts and in the circumstances of the case and in law, the Ld. AO has erred in not allowing the deduction of provision for warranty of Rs. 11,11,70,277 for AY 2017-18. 2.2. On the facts and in the circumstances of the case and in law, the Ld. DRP erred in not following its earlier decisions for AY 2010-11, AY 2011-12 and AY 2014-15 and the decisions of the Hon’ble Income Tax Appellate Tribunal (“ITAT”) for AY 2008-09, AY 2010-11, AY 2011-12, AY 2012-13, AY 2013-14, AY 2014-15 and AY 2016-17 in appellant’s own case, allowing the deduction of provision for warranty. 2.3. On the facts and in the circumstances of the case and in law, the Ld. DRP directed the Ld. AO, that while allowing the deduction, to verify the detail of provision created in preceding years, actual expenditure, earlier provision utilized, the balance provision carried forward and year-wise sales so as to justify the basis for provision for warranty and that the actual expenses on warranties incurred in subsequent years and excess provision written back also are consistent. However, the Ld. AO grossly erred in not following the above directions and disallowed the provision for warranty on misconceived & irrelevant considerations. 2.4. On the facts and in the circumstances of the case and in law, the appellant submitted complete details before the Ld. AO and the Ld. DRP including sample copy of contracts showing extracts for clause of warranty, party-wise details of warranty claims payable as per contracts for which provision was made in AY 2017-18 and details of provision for warranty made in earlier years and amount written back out of such provision and offered to tax. The Ld. AO grossly erred in not appreciating the above details; 2.5. On the facts and in the circumstances of the case and in law, the Ld. AO has grossly erred in not following the decisions of the Hon’ble ITAT in appellant’s own case for AY 2008- 09, AY 2010-11, AY 2011-12, AY 2012-13, AY 2013-14, AY 2014-15 and AY 2016-17 allowing the deduction of provision for warranty. Further, the principles for allowance of provision for warranty laid down by the judicial precedents have been fulfilled i.e., provision has been created on scientific basis, future outflow of resources, fulfils matching concept etc.; 2.6. Without prejudice to the above, provision for warranty utilized/ expenditure incurred in AY 2017-18 itself should be allowed to the appellant. General 3. On the facts and in the circumstances of the case and in law, the Ld. AO has erred in levying interest u/s 234B of the Act of Rs. 2,44,71,350 for AY 2017-18.
4. On facts and in law, the Ld. AO erred in initiating penalty proceedings u/s 270A of the Act for under reporting of income.”
Briefly stated the facts are that the assessee company was incorporated in 1976 and is a wholly owned subsidiary of KHD Humboldt Wedag International AG Cologne, Germany, (“KHD AG”). The assessee is engaged in providing services such as designing and engineering, project management, supply of technology and equipment and supervision of erection and commissioning of cement plants and related equipments. The assessee e-filed its revised return of income for assessment year 2017-18 on 05.04.2018 declaring total income of Rs. 66,51,32,950/-.
4.1 During assessment year 2017-18, the assessee undertook certain international transactions with its associated enterprises (“AEs”) and therefore the assessee’s case was referred to the Ld. Transfer Pricing Officer (“TPO”) on 13.09.2019 for determination of arms length price (“ALP”) in respect of such international transactions in accordance with the transfer pricing provisions under the Act. All the international transactions of the assessee were accepted by the Ld. TPO to be at ALP except the benchmarking of Intra Group Services (“IGS”). The assessee paid the following IGS charges for availing the following services from its AEs:-
Head Amount (Rs.) Supervision services 23,39,47,534/- SAP integration services 3,21,063/- Central services 14,00,28,013/- 4.2 The assessee in its transfer pricing documentation has followed transaction- by – transaction approach. The assessee applied Transactional Net Marginal Method (“TNMM”) to benchmark its transaction for availment of Supervision services and SAP integration services and Cost Plus Method (“CPM”) for availment of Central services from its AEs.
4.3 In respect of the above transactions, the Ld. TPO during the transfer pricing proceedings asked the assessee to substantiate as to how these transactions have been treated in its books of account and to furnish certain details thereof. The assessee submitted its written reply on 21.12.2020 and 29.12.2020 which were not accepted by the Ld. TPO. The Ld. TPO observed that assessee has not offered cogent evidence in support of its claim that mark-up was paid only on internal cost and third party cost are charged on cost-to-cost basis. The Ld. TPO considering the directions of the Hon’ble DRP in assessee’s own case for assessment year 2010-11 and in absence of supporting documents allowed the service fee for availing Supervision services and SAP integration services amounting to Rs. 23,42,68,597/- (Rs. 23,39,47,534 + 3,21,063) only to the extent of cost and the mark-up charged thereon by the AE was disallowed. Accordingly, the Ld. TPO proposed an adjustment of Rs. 90,10,331/-. In respect of availing of Central services amounting to Rs. 14,00,28,013/-, the Ld. TPO relied on the Hon’ble DRP’s order in the past years and allowed the service fee to the extent of cost and disallowed the mark-up charged thereon by the AE resulting in an adjustment of Rs. 66,68,001/-. Hence, the Ld. TPO vide his order dated 15.10.2019 under section 92CA(3) of the Act concluded that the AO shall enhance the income of the assessee by Rs. 1,56,78,332/- (Rs.
90,10,331 + Rs. 66,68,001) on account of disallowance of mark-up on the cost allocated for IGS.
4.4 On raising objection against the draft assessment order, the Hon’ble DRP relied on their order for earlier assessment years 2014-15 and 2016-17 wherein the similar issue arose for consideration and the Panel disallowed the mark-up on the cost allocated for IGS by recording the following finding in para 5.4.4 of their order dated 15.12.2021:-
5.4.4 as the factual matrix of the case remains the same even in the relevant assessment year 2017-18, the Panel finds no reason to deviate from the analysis and direction given on intra group services for the assessment years 2014-15 and assessment year 2016-17. The above grounds are accordingly disposed off . 4.5 Pursuant to the directions of the Hon’ble DRP, the Ld. AO framed the final assessment order dated 31.01.2022 by making an addition of Rs. 1,56,78,332/- to the returned income of the assessee.
Aggrieved, the assessee is in appeal before the Tribunal.
At the outset, the Ld. AR submitted that the issue under consideration is squarely covered in favour of the assessee by the combined order of the Hon’ble Tribunal for the preceding assessment years 2014-15 and 2016-17 and that there is no change in facts of the case for assessment year 2017- 18. The Ld. AR further submitted that the rule of consistency should be followed. The Ld. AR argued that the Ld. TPO and the Hon’ble DRP disregarded the compressive and methodical economic analysis carried out by the assessee in respect of IGS charges to its AEs. The assessee has undertaken the impugned transactions in the past years as well and there has been no change in the facts and circumstances of the case in this year (i.e. AY 2007-18) viz-a-viz those years. The Ld. DR relied on the order of the Ld. AO/ Hon’ble DRP.
We have heard the Ld. Representatives of the parties and perused the material on record. In our considered view, the assessee deserves to succeed. 6 Ground No. 1.1 to 1.5 pertaining to transfer pricing adjustment of Rs. 1,56,78,332 7.1 Our attention was drawn to the order of the Hon’ble Tribunal for the assessment years 2014-15 and 2016-17 in assessee’s own case wherein similar issue arose for consideration and the Hon’ble Tribunal keeping in view the entire facts and circumstances of the case deleted the entire adjustment made on this account by allowing the mark-up charged by the AEs in the services provided to the assessee. The relevant extract of the order of the Hon’ble Tribunal for the assessment years 2014-15 and 2016- 17 in and ITA No. 475/Del/2021 respectively dated 18.08.2021 is reproduced below:-
“4. The assessee paid Rs.8.28 lacs for supervising charges, and Rs.14.25 Crores for central services. On supervision services, the AE charged a net profit mark-up of 4% on the internal cost incurred on the basis of number of hours spent by its personal in providing such services. On the central services, the AE charged 5% profit mark-up on internal cost while third party costs are charged on cost to cost basis.
5. The mark-up of 4% and 5% has been disallowed by the TPO and accordingly enhanced the income of the assessee based on the id. DRP observations for the year 2010-11. For the sake of ready reference, the same is reproduced as under: "3.3.2. In the assessee's case, the intra- group services relate to general administration, finance and accounting, coordination, general management, corporate and project financing, recruitment and education. It is noted that the assessee is an entrepreneur in its own right and is engaged in engineering, procurement and commissioning projects for the third party clients. It procured orders on independent basis and also carried out the project on its own. It is hardly operating as an extension of AE or catering exclusively to the AE. It virtually undertakes all the risks associated with rendering services, marketing and performs various complex roles. Therefore, the ratio of Supreme Court decision in the case of Morgan and Stanley & Co. hardly applies on the facts of the assessee's case. The assessee has also provided substantial evidence in form of e-mails and correspondence with the AE in respect of the services rendered by the AE. On going through the same, it clearly comes out that the AE was rendering services which were beneficial for the assessee in conducting its business. No doubt, some benefit of the services may have accrued to overall group also. But the primary beneficiary was definitely the assessee. Under these circumstances, it would not be proper to term the services rendered by the AE as stewardship activity.
3.3.3. Corning to the quantum of payment for the services, it is seen that from the total cost of services, cost of stewardship activity services/duplicate services is first removed. The remaining cost is allocated to different organizations of the group. The assessee pays the cost of services allocated to it plus ore-agreed mark up. In the course of hearing, the assessee was asked to justify the mark up. However, no detailed justification was provided in this regard. It was only stated that since the AE was providing the services, it was entitled to earn some margin on the same. However, as discussed earlier, while the primary beneficiary of the services is the assessed, there are also some incidental benefits accruing to the group. The parent company gets benefited by better synergies, scale of economy, better coordination and reporting. Considering this, the AE, in our opinion, was not justified in charging any mark up on the cost of services. The arm's length price of the services is therefore decided at the actual cost. The adjustment is therefore sustained to the extent of mark up only. The TPO is directed to reduce the adjustment accordingly."
6. The main argument of the Id. AR was that these transactions are benchmarked by using TNMM and furnished that TP documentation whereas the TPO did not follow any prescribed method and the entire mark-up is disallowed without giving any reasons. The observation of the revenue that the parent company gets benefited by better synergies, scale of economy, better coordination and reporting cannot be accepted.
7. While the assessee avails supervision services from its AEs and pays mark-up charges, it also provides such services to the AEs for their third party contracts and receives mark-up charges. The pricing basis and the results arising from the same have been accepted by the TPO. Disallowing the mark- up on receipt of services while in-principle accepting the provision of similar services rendered having similar intent and basis of pricing cannot be valid ground to disallow the mark-up. It is not out of contest to note that no such disallowance has been made on the mark-up in the case of the assessee AY 2007-08 to 2012-13 and AY 2015-16.
Hence, keeping in view, the entire facts and circumstances, the contention of the revenue that the AE invariably derives some benefit and hence no mark-up should be charged, cannot be accepted.” 7.2 Keeping in view the rule of consistency and more so the position that the facts for the assessment year 2017-18 remain the same as that of assessment year 2014-15 and 2017 in respect of the impugned transactions with its AE, we respectfully following the order of the Hon’ble Tribunal (supra) direct the Ld. AO to delete the addition of Rs.1,56,78,332/-. Ground No. 1.1 to 1.5 pertaining to the adjustment of Rs. 1,56,78,332 to the total income of the assessee on account of difference in ALP of its international transactions with its AEs relating to availment of supervision services, SAP services and Central services are thus allowed.
Ground No. 2.1 to 2.6 pertaining to provision for warranty of Rs. 11,11,70,277 8. Ground No. 2.1 to 2.6 relates to denial of deduction of provision for warranty of Rs. 11,11,70,277/- by the Ld. AO. The Hon’ble DRP vide its order dated 15.12.2021 directed the Ld. AO to examine and verify complete details of the data of provision created in preceding years, actual expenditure during the year under consideration, earlier provision utilised, the balance provision carried forward and year-wise sales so as to justify the basis for provision for warranty and that the actual expenses of warranties incurred in subsequent years and excess provision written back also are consistent. However, the Ld. AO passed the final order disallowing the provision for warranty which has been challenged by the assessee before the Tribunal.
8.1 The Ld. AO in para 4 of his final assessment order dated 31.01.2022 concluded that the assessee company has booked merely an estimated liability not based upon any scientific methodology and that though it is a legacy issue yet has not attained finality. Therefore, the provision for warranty of Rs. 11,11,70,277/- is treated as an unascertained liability and hence disallowed in the computation of total income. The Ld. AO at the end of his order noted that the assessee has filed its detailed response vide submissions dated 15.03.2021 and 23.04.2021 regarding the issue of ‘provision for warranty’, these submissions are considered by him but not found tenable.
8.2 The Ld. AR drew our attention to the fact that the issue under consideration has been consistently decided in favour of the assessee for earlier assessment years in its own case by the co-ordinate bench of Hon’ble Tribunal. The Hon’ble Tribunal has allowed the deduction of provision for warranty in earlier assessment years from AY 2008-09 to AY 2016-17 in assessee’s own case (ITA No.2295/Del/2013, ITA No.1057/Del/2016, ITA No.567/del/2015, ITA No.4663/Del/2017, ITA No.4664/Del/2017, ITA No.8119/Del/2018, ITA No. 475/del/2021). The assessee has been consistently following policy of making provision for 9 warranty as per the terms of contract. Since provision for warranty made during the assessment year 20017-18 is on the same basis as in earlier years, the provision for warranty of Rs. 11,11,70,277 is allowable following the orders of the Hon’ble ITAT (supra) for earlier years.
8.3 The Ld. AR also brought to our notice the judgment of the Hon’ble Supreme Court in the case of Rotork Controls India (P) Ltd. vs. CIT [314 ITR 62 (SC)]. The Ld. DR submitted that the orders of the Tribunal (supra) are challenged by the Revenue before the Hon’ble High Court and the matter is sub-judice. He submitted that the methodology followed by the assessee for creating provision for warranty needs to be verified which the assessee claims to be made on scientific basis. Hence, this issue may be restored to the file of the Ld. AO to verify assessee’s claim.
We have considered the rival submissions and perused the material on record. We find that the contract between the assessee and its customers invariably contains clauses for warranty for default in functioning of equipment etc. supplied to customers as per terms of the contract. During the assessment year 2017-18, the assesee anticipated that expenses for warranty would be incurred by it in respect of contract entered with customers. Accordingly, for such obligation the assessee made provision for warranty of Rs. 11,11,70,277/- in its books of account by debiting profit and loss account and taken it as an allowance in the return of income for the assessment year 2017-18. To substantiate its claim, the assessee furnished the details i.e. name of the party, project no. and amount of provision for warranty created for assessment year 2017-18 and the relevant extracts of the contracts. Perusal of the relevant clauses of the contracts reveals that the assessee is under contractual obligation to discharge warranty claims raised by the customers arising in a later period. However, as per mercantile system of accounting being followed by the assessee, it is required to make provision for warranty in the year in which it recognised revenue from contracts by following the principle of matching of revenue and cost.
9.1 It was pointed out that that the assessee makes provision for warranty @ 3% of the contract value upon completion of deliveries based upon the historical trend and other relevant factors. In support thereof the assessee submitted the below tabular presentation providing a reconciliation of provision for warranty for various years i.e. provision created in preceding years, actual expenditure during the year under consideration, earlier provision utilized, the balance provision carried forward:
Opening Closing Contract AY Additions Reversal Utilization balance balance revenue 2009-10 35,58,78,785 10,22,90,817 5,13,94,994 25,54,00,584 15,13,74,024 3,92,60,86,075 2010-11 15,13,74,024 28,81,12,854 4,50,43,319 9,11,22,433 30,33,21,126 3,55,32,53,339 2011-12 30,33,21,126 18,76,87,197 3,24,89,702 9,49,25,941 36,35,92,680 4,60,22,79,741 2012-13 36,35,92,680 23,89,75,515 6,28,00,944 24,32,96,504 29,64,70,747 3,39,46,41,837 2013-14 29,64,70,747 41,88,64,157 2,02,09,842 20,55,67,885 48,95,57,177 2,57,40,20,904 2014-15 48,95,57,177 5,02,88,810 2,68,65,259 5,68,84,319 45,60,96,407 3,99,17,38,396 2015-16 45,60,96,407 13,99,70,672 15,15,91,912 18,70,47,392 25,74,27,775 2,34,16,14,840 2016-17 25,74,27,775 19,29,33,966 9,35,49,418 13,45,05,485 22,23,06,838 2,66,79,96,793 2017-18 22,23,06,838 14,75,47,954 3,63,77,677 15,97,256 17,37,51,550 3,17,10,09,143 9 years’ 35,58,78,785 1,76,66,71,942 52,03,23,067 1,42,84,76,108 17,37,51,550 trend 9.2 While estimating the warranty expense for the year, the assessee transforms various relevant factors having a bearing on the determination of warranty expense into statistical information. These factors may relate to data with regard to the past historical experience, failure rate experienced in the past, increase in sales volume of the products under warranty, technical evaluation, nature and use of product, length of warranty with regard to goods sold and their spare parts, etc. The provision made by the assessee varies year-by-year depending upon the possibility of warranties claim to be made in future years. The assessee has utilized provision for warranty of Rs. 15,97,25,565 during AY 2017-18.
9.3 The assessee has been consistently making the claim of deduction for provision of warranty every year following the same methodology which in our view is tenable. The provision for warranty has been made @3% of the contract value and the unutilized portion has been reversed at a regular intervals from year to year. We also note that this issue has been under 11 litigation every year beginning from the assessment year 2008-09. The coordinate bench of the Tribunal in assessee’s own case (supra) has in all the prior years decided this issue in favour of the assessee by allowing the deduction of provision for warranty. It is also the case of the assessee that the Hon’ble Supreme Court in the case of Rotork Controls India (P) Ltd. vs. CIT 314 ITR 62 (SC) allowed the provision for warranty as a permissible deduction on the basis of certain parameters fulfilled by the assessee in that case. Since the parameters/ conditions laid down by the Hon’ble Supreme Court in Rotork Controls case (supra) are fulfilled by the assessee the ratio of the said case squarely applies to the case of the assessee.
9.4 From the perusal of the Hon’ble Tribunal’s order for earlier years (supra), we note that the Rotork Controls case (supra) has been duly considered by the Tribunal wherein the Tribunal has categorically recorded its finding that Rotork Controls case is squarely applicable to the case of the assessee.
9.5 There is no merit in the argument of the Ld. DR that the assessee has not applied any scientific/ reasonable methodology for claiming deduction of provision for warranty in view of the explanation offered by the assessee.
9.6 Observation of the Ld. AO is that this issue is a legacy and yet has not attained finality. This has been emphasised by the Ld. DR also. Since the issue under consideration is sub-judice before the higher forum, we have respectfully to follow the orders of the coordinate bench of the Hon’ble Tribunal (supra). We do so and allow the deduction of provision for warranty of Rs. 11,11,70,277/-.
Ground No. 3 and 4 – General 10. Ground No. 3 and 4 relating to charging of interest under section 234B of the Act of Rs. 2,44,71,350/- and levy of penalty respectively are consequential.
In the result, the appeal of the assesee is allowed.
Now we take up STAY NO. 68/Del/2022 in
Since the appeal in (supra) has been allowed on merits in favour of the assessee, the stay application becomes infructuous.
In the result, Stay No. 68/Del/2022 is dismissed.