JCIT, BANGALORE vs. M/S DELL INTERNATIONAL SERVICES INDIA PVT. LTD.,, BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL “C” BENCH : BANGALORE BEFORE SHRI GEORGE GEORGE K., JUDICIAL MEMBER AND Ms. PADMAVATHY S, ACCOUNTANT MEMBER

IT(TP)A No.641/Bang/2016 Assessment year : 2011-12 The Joint Commissioner of Vs. M/s.Dell International Services Income Tax, LTU, India Private Limited, Bangalore. (for the merged entity Dell India Private Limited), Bangalore – 560 071. PAN : AAACH 1925Q APPELLANT RESPONDENT

IT(TP)A No.642/Bang/2016 Assessment year : 2011-12 M/s.Dell International Services Vs. The Joint Commissioner of Income Tax, LTU, India Private Limited, Bangalore. (for the merged entity Dell India Private Limited), Bangalore – 560 071. PAN : AAACH 1925Q APPELLANT RESPONDENT

Revenue by : Shri Sri.Pradeep Kumar, CIT(DR)(ITAT), Bengaluru. Assessee by : Shri T. Suryanarayana, Advocate

Date of hearing : 04.11.2022 Date of Pronouncement : 11.11.2022

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O R D E R Per Bench These cross appeals by the assessee and revenue are directed against final assessment order dated 29.01.2016 passed u/s 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961 [the Act]. The relevant assessment year is 2011-12.

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adjustment aggregating to Rs. 18,00,81,299/-, comprising of the following:

A. Adjustment determined by bifurcating the marketing and business support services segment into ITES segment (adjustment of Rs. 3,73,98,104/-) and MSS segment (adjustment of Rs. 2,89,47,259/-); and B. Adjustment of Rs. 11,37,35,936/- determined in respect of the warranty expenses. 4. Pursuant to TP adjustment, a draft assessment order dated 31.03.2015 was passed by the AO in which the aforesaid TP adjustments were incorporated. Further, the A.O. also made various additions / disallowance on corporate tax issue.

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IT(TP)A No.642/Bang/2016 (Assessee’s appeal)

“I. Transfer pricing 1. Order/ Directions bad in law and on facts

1.1 The order issued by the Joint Commissioner of Income- tax (`JCIT'), Large Tax Payers Unit (`LTU'), Bangalore [(`Assessing Officer') or (`A0')], under section 143(3) read with section 144C (13), pursuant to the directions issued by the Hon'ble Dispute Resolution Panel [`DRP' / Ld. Panel], is bad in law and on facts and is in violation of the principles of natural justice. 1.2 Without prejudice to the generality of the above, the order issued by the AO is bad in law insofar as the fact that the AO did not issue to Dell India Private Limited (`DIPL'), 'the Appellant or 'the Company'), a show cause notice, as per proviso to section 92C(3) of the Income-tax Act, 1961 ['the Act']. 1.3 The directions issued by the Ld. Panel did not take cognizance of the objections raised by the Appellant in relation to the transfer pricing matters. 1.4 On the facts and in the circumstances of the case and in law, the Ld. Panel and AO/TPO erred in not demonstrating that the motive of the Appellant was to shift profits outside India by manipulating the prices charged in the international transaction, which is a pre- requisite condition to make any adjustment under the provision of Chapter X of the Act.

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Erroneous bifurcation of marketing and business 2. support services into IT enabled services (`ITeS') and Marketing support services

2.1 The AO/ TPO has erred in fact and in law, in arbitrarily bifurcating Marketing and business support services segment into ITeS and Marketing support services without any basis. The Ld. Panel erred in upholding the actions of the AO/ TPO. 2.2 The AO/ TPO has erred on facts in arbitrarily apportioning the cost between ITeS and Marketing support services segments. The Ld. Panel erred in upholding the actions of the AO/ TPO.

2.3 The Ld. Panel and the AO / TPO erred in rejecting the value of international transactions as recorded in the books of account, as the arm's length price. 2.4 The Ld. Panel and the AO / TPO erred in determining a new arm's length price in substitution of the arm's length price determined by the Appellant.

2.5 The Ld. Panel and the AO/ TPO erred in law in holding that the fresh comparability analysis using non contemporaneous data conducted by the TPO and further substituting the Appellant's analysis with fresh benchmarking analysis on his own conjectures and surmises. Thus, the Appellant prays that the fresh benchmarking analysis conducted by the TPO is liable to be quashed. 2.6 The AO/TPO erred on facts in rejecting the comparable companies arrived at in the Transfer Pricing Study without considering the functional and risk analysis of the Appellant. The Ld. Panel erred in upholding the actions of the AO/ TPO.

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2.7 The AO/ TPO grossly erred on facts in benchmarking the transactions of the marketing and business support services of the Appellant with companies operating as full-fledged entrepreneurs without considering the differences in the functions performed, assets employed and risk undertaken by the Appellant vis-à-vis comparable companies. The Ld. Panel erred in upholding the actions of the AO/ TPO. 3. Determination of arm's length price by the TPO in relation to the Marketing Support Services segment (`MSS Segment')

3.1 The AO/ TPO erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability. The Ld. Panel erred in upholding the actions of the AO/ TPO. 3.2 The AO/ TPO erred in facts in arbitrarily rejecting companies based on their financial results without considering the functional comparability. The Ld. Panel erred in upholding the actions of the AO/ TPO.

3.3 The AO/ TPO also erred on facts in erroneously computing the margins of the assessee and companies identified as comparable by the TPO. The Ld. Panel erred in upholding the actions of the AO/ TPO. 4. Determination of arm's length price by the TPO in relation to the impugned ITeS Segment

4.1 The Ld. Panel and the AO/ TPO erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability, such as, (i) companies whose data for financial year (`FY') 2010-11 was not available, (ii) companies with ITeS service revenue less than 75%

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of total operating revenue, (iii) companies with related party transactions greater than 25% of sales (iv) companies with export sales less than 25% of total sales, (v) companies with different financial year ending (i.e. other than 31 March 2011) and (vi) companies having persistent losses up to and including financial year 2010- 11.

4.2 The AO/ TPO also erred on facts in arbitrarily accepting companies without considering the turnover and size of the Appellant and comparables. The Ld. Panel erred in upholding the actions of the TPO. 4.3 The AO/ TPO also erred on facts in erroneously computing the margins of certain companies identified as comparable by the AO/ TPO.

4.4 The AO/ TPO erred in including Accentia Technologies Ltd., ICRA Online Ltd (seg), Jeevan Scientific Technology Ltd., Jindal lntellicom, despite these companies being functionally dissimilar to the Appellant. The Ld. Panel also erred in confirming the same.

4.5 The Ld. Panel erred in arbitrarily rejecting Cosmic Global Limited and e4e Healthcare Business Service Ltd. despite being functionally comparable companies. 5. Erroneous adjustment of Rs. 9.61 Crores as Warranty cost to be received from AEs 5.1 The TPO erred on facts and in law in arbitrarily proposing an adjustment on account of warranty cost in relation to the marketing support services, to the tune of INR 9.61 Crores without considering the facts of the Appellant. The Ld. Panel erred in confirming the same. 6. Erroneous data used by the TPO

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6.1 The AO/ TPO has erred in law and the Ld. Panel further erred in confirming use of data, which was not contemporaneous and which was not available in the public domain at the time of conducting the transfer pricing study by the Appellant.

6.2 The Ld. Panel and the AO / TPO erred in law and on facts in disregarding the application of multiple-year data while computing the margins of comparable companies. 7. Non-allowance of appropriate adjustment to the comparable companies by the Ld. Panel and AO/ TPO AO/ TPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (i) accounting practices, (ii) marketing expenditure adjustment, (iii) research and development expenditure adjustment, (iv) working capital, (iv) risk profile and (v) working capital adjustment to account between the Appellant and the comparable companies. 8. Variation of 5% from the arithmetic mean

The AO/ TPO erred in law in not granting the benefits of proviso to section 92C(2) of the Act available to the Appellant.

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Bifurcation of marketing and business support services segment into ITES and MSS segments (Ground Nos.I(2) to I (4) and I(6) to I(7)) 7. The Assessee provides business support services to Dell Global B.V. Singapore Branch (DGBV) in relation to the products sold by the said entity to its customers in India. The business support services comprise of the following services:

- Telephonic support services; - Marketing support services; and - Logistic support services. 8. The Assessee provides telephonic support services for standard problems to the customers who purchase the products sold by DGBV in India. In case an on-site service is required, the Assessee send third party service provider for such services. The technical support services include services in relation to products sold by DGBV which are under warranty period. In relation to warranty services, the cost of third party service provider and spares are borne by the Assessee, and recovered from DGBV.

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year 2009-10. The DRP confirmed the TPO’s order. Aggrieved the assessee is in appeal before the Tribunal.

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“information technology enabled services” means the following business process outsourcing services provided mainly with the assistance or use of information technology, namely:— (i) back office operations; (ii) call centres or contact centre services; (iii) data processing and data mining; (iv) insurance claim processing; (v) legal databases; (vi) creation and maintenance of medical transcription excluding medical advice; (vii) translation services; (viii) payroll; (ix) remote maintenance; (x) revenue accounting; (xi) support centres; (xii) website services; (xiii) data search integration and analysis; (xiv) remote education excluding education content development; or (xv) clinical database management services excluding clinical trials, but does not include any research and development services whether or not in the nature of contract research and development services;” 13. From the above definition, it is evident that merely because services are rendered using IT medium, they cannot be termed as ITES. We also notice that the coordinate bench of the Tribunal in assessee’s own case has considered the same issue and held that –

“7.8 We have heard rival submissions and perused the material on record. The TPO held that services under the technical and marketing services segment is essentially dissemination of information and the assessee is acting as communication channel

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between the customers and the AEs using IT medium. According to the TPO, those services rendered by the assessee are to be considered as ITES. After holding so, the TPO bifurcated segment into IT segment and MSS segment and bench marked them separately. 7.8.1 In this context, it is pertinent to note that for assessment year 2013-2014, the DRP granted relief to the assessee by holding that services rendered are in the nature of marketing support services. Copy of the DRP’s order for assessment year 2013-2014 is placed on record at page 770 Vol.4 of the case law compilation. The DRP has given the above directions at page 10. The relevant finding of the DRP in assessment year 2013-2014 reads as follows:- “Having considered the submissions, and on perusal of the details filed, we note that as per the Services Agreement entered between the assessee and Dell Global BV (Singapore branch) dated 01.01.2009, the assessee is required to prove certain technical support to the customers who purchase products from the assessee, to provide logistics support to ensure delivery of products and services to the customers and also provide marketing support and Sales promotion services. The technical services are provided to the customers of products, and as such cannot be compared to the function of provision of ITES service. Therefore. we are no in agreement with the TPO's view in comparing such services to call entre activity, and there is no information for the TPO to take such a view. Besides, we note that all these functions is provision of logistics support, marketing support and technical support have interrelation in the facts & circumstances of the case. Therefore, it would not be appropriate to segregate them into Technical Services & Marketing Supports services. Accordingly, the TPO’s action in such segregated analysis is disapproved. The TPO is directed to consider the Marketing support and Technical Support as an integrated function and such integrated revenue of these two activities may be benchmarked as Marketing Support Service. Accordingly, the TPO's benchmarking analysis with regard to Marketing Support Service would be considered applicable for this integrated Market Support & Business Support Services. The TP analysis made by the TPO by taking comparables relating to IES segment are here

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by rejected. The TPO is accordingly directed to recompute the- adjustment in line with the above direction. We also note here, that in view of the above, the objections raised in 22-26, against comparability analysis of comparables relating to ITES functions are rejected as infructuous.” 7.8.2 The functions performed by the assessee under this segment are prima facie identical for the concerned assessment year and for the assessment year 2013-2014. For assessment year 2013-2014, when the DRP had held that services rendered by the assessee are in the nature of marketing and support services and since no appeal preferred by the Revenue to the ITAT, the matter had attained finality. Therefore, we are of the view that the entire TP issue raised under marketing support services segment needs to be examined afresh by the AO / TPO in the light of the DRP’s directions for assessment year 2013-2014. It is ordered accordingly.” 14. In the year under consideration, the facts are similar to that of assessment year 2009-10 and therefore respectfully following the decision of the coordinate bench of the Tribunal, we remit the issue back to the AO/TPO for fresh consideration in the light of the DRP’s directions for assessment year 2013-2014. It is ordered accordingly.

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Adjustment determined in respect of warranty cost – Ground I(5)

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“8.7. We have heard rival submissions and perused the material on record. The assessee had submitted that the amount of Rs.211.42 crore does not pertains to the sales made by the AEs in India and it pertains solely to the sales made by the assessee. The DRP in its directions held that the assessee was to show that expenses in relation to providing support services for AEs warranty obligation are either reduced from the cost or accounted for separately. The DRP in fact directed that since the services in relation to the warranty obligations are provided by third party service providers and the assessee is only coordinated for the same, no mark up is warranted. The relevant finding of the DRP in this regard reads as follows:- “6.6.6 The assessee is directed to demonstrate to the TPO that the above reimbursement has either been reduced from the costs or accounted for separately. In absence of such demonstration, the TPO can take the above to be a part of the warranty costs debited to the P&L account and effect suitable adjustment. Since the services related to warranty are being handled by a third party and the assessee is being used only as a medium, the TPO is not correct in charging a markup on this amount. Hence, the objection relating to markup on the warranty cost is upheld. The TPO cannot charge a markup on warranty amount as such services are not rendered by the assessee to its AE.” 8.7.1. In the light of the above directions of the DRP, which we are in consonance with the TPO, is directed to reexamine the issue raised in ground 10 afresh. It is ordered accordingly.” 20. Respectfully following the above decision we direct the TPO to re-examine the issue raised in ground no.5 afresh. It is ordered accordingly. This ground is allowed for statistical purposes.

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CORPORATE TAX ISSUES

Provision for warranty and warranty expenses (Ground No.II(1))

II. Corporate Tax 1. Disallowance of Provision for Warranty— Rs. 2,165,200,000 1.1 The learned Assessing officer ("AO") has erred in stating that the appellant has failed to substantiate the basis of creation of provision for warranty without appreciating the detailed back up workings submitted by the appellant substantiating the basis of creation of provision for warranty. 1.2 The learned AO ought to have appreciated the fact that the methodology followed by the Company for recognizing the provision for warranty of Rs. 216.52 crores is in line with the principles laid down by the Hon'ble Supreme Court in the case of Rotork Controls India (P) Ltd vs. CIT [2009] 180 Taxmann 422 which has also been upheld by the Honourable Tribunal in the appellant's own case for AY 2002-03 & 2003-04 vide order dated 13.02.2015. 1.3 The Honourable DRP having relied on the decision of the Honourable Tribunal in the appellant's own case has erred in not following the same.” 22. The Assessee had created a provision of Rs. 216,52,00,176/- towards its obligation to provide warranty services, which it claimed as a deduction. The AO disallowed the entire provision for warranty on the ground that it is not scientific and also disallowed expenses towards

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utilization of warranty on the ground that no evidence was submitted in support of such warranty expenses.

(i) The assessee has a scientific method of creating the provision and submits that the actual expenses incurred in servicing the customers under warranty period are being utilized from the warranty provision created for such purpose. The details are as follows:-

Particulars Amount (INR) Opening balance of provision for warranty (A) 129,25,48,000/- Add: Provision for warranty created during the 216,52,00,176/- year (B) Less: Actual expenses incurred during the year (224,26,51,541/-) (C) Closing balance of provision for warranty (D) = 121,50,96,466/- A+B-C

(ii) The methodology followed by the assessee in estimating the warranty cost and tracking the related expenses is briefly explained as under:- a. The assessee has a specialized warranty accounting team which tracks the incidents reported and associated cost of providing warranty services for each of the product;

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b. The total sales are divided into various categories of IT hardware products based on the warranty period attached to each such product. The faults are tracked on the basis of a unique identification number attached to each IT hardware so as to identify cases of faults; c. Thus, the warranty cost is nothing but the product of number of incidents reported and cost involved in servicing each unit under various categories of products; d. The system of tracking the faults and related warranty costs is extremely scientific with minimal margin of error as it is based on actual faults reported and costs incurred in servicing them. e. The assessee neither creates the provision customer wise nor the utilization of such provision for warranty would be tracked customer wise. The tracking is based on the products and not customers. The warranty service for products sold is carried out based on the service tag number ascribed to each such product. Hence, non- submission of the list of customers for whom the warranty expense has been incurred cannot be the basis to conclude that the assessee does not create provision for warranty on a scientific basis, as has been done by the AO. f. Further, there are automatic reversals of the provision when products go out of warranty period. For the purpose of estimating the warranty provision, the assessee takes into account only those units in respect of which the warranty period has not expired as on the date of estimating the provision. g. Thus, the closing provision as on 31st March 2011 represents the cost involved for servicing the units for which the warranty period has not expired as on that day. h. Accordingly, the system would automatically exclude those products for which the warranty period has expired and include only those products (i.e. products sold in past for which warranty period has not expired and products sold during the year with a warranty commitment) for which warranty period has not expired. i. Thus, based on the above accounting methodology, as the reversals get adjusted with the provision required to be created in the subsequent years, it, in effect, leads to the same being credited to the Profit and Loss account in the subsequent year.

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j. Detailed submissions as regards the methodology of creating the provision is made before the AO in the submissions dated 23.01.2015 (at pages 559-564 of Volume 2 of the paper book)accompanied by complete back-up workings of the provision (at pages 577-581 of Volume 2 of the paper book). (iii) It is submitted that this issue is covered by the decisions of this Hon’ble Tribunal in the Assessee’s own case for the assessment year 2009-10 (Order dated 18.03.2022 passed in IT(TP)A No. 269/Bang/2014)- please see pages 906-909 of the caselaw compendium; and Assessee’s own case for the assessment year 2010-11 (Order dated 18.08.2022 passed in IT(TP)A Nos. 562 and 400/Bang/2015) -at pages 955-961 of the caselaw compendium. 25. Without prejudice, the detailed invoice-wise listing of actual expenses incurred of Rs. 216.52 crores were produced before the AO vide submission dated 23.01.2015 at page 582-719, Volume 2 of the paper book, and therefore, it is submitted that the deduction ought to be allowed

“12.5 We have heard rival submissions and perused the material on record. As regards the provision for warranty, the learned AR explained that the methodology followed by the assessee for estimating warranty cost is on a scientific basis and it is based on past years experience. The detailed explanation of the learned AR is recorded in para 12.2 (supra), hence, the same is not reiterated. The Tribunal in assessee's own case for assessment year 2002-2003, 2003-2004 and 2005-2006 had dismissed

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the appeal of the Revenue and held that the provision of warranty claimed is based on scientific basis and held that it is entitled for deduction. The relevant finding of the Tribunal in assessee's own case Dell International Services India (P.) Ltd. v. Dy. CIT [2018] 89 taxmann.com 44 (Bang. - Trib.), reads as follows:— "21. We have given a very careful consideration to the rival submissions. The basis on which provision for warranty was made by the assessee was that the Assessee has arrived at a model for ascertaining the warranty cost, based on the type of equipment, periodicity of warranty and nature of commitment. The Assessee has a specialized warranty accounting team which tracks the incidents reported for each product country-wise and associated cost of providing warranty services. The total sales are divided into various categories of IT hardware products based on the warranty periods attached to each such product. The faults are tracked on the basis of a unique identification number attached to each IT hardware so as to identify cases of faults. The warrant cost is a product of the Field Incident Rate i.e., the number of repairs and the Cost per Incident. Field Incident Rate is determined based on the actual faults reported over the earlier years, the Cost per Incident is determined a scientific basis based on the past experience, which is the sum of the following: - Cost of Spare Parts; - Cost of logistics; and - Labour cost The Assessee writes back the difference between the warrant provision made for a particular year and actual expenditure incurred in the subsequent year, in the subsequent year. 22. It is not in dispute before us that the basis on which the provision for warranty was made was identical in AYs 2002-03 & 2003-04 as well as in AY 2005-06. The Tribunal has in the appeal for the AYs 2002-03 & 2003- 04 after considering the method of providing for warranty liability by way of a provision, specified that the provision made was based on past history and was on scientific method of estimating liability on account of warranty claims. It is clear from the chart which has been extracted in the order of assessment that as and when the period of warranty expires, the assessee writes back the provision made in the books of account to the extent it relates to the warranty liability which the assessee does not incur and which was already provided by way of a provision and allowed as deduction in the past. It appears to us that the

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provision made by the assessee is scientific and is based on past history. We are also of the view that in view of the parity of basis of provision of warranty in AYs 2002-03 & 2003-04 and AY 2005-06, the ruling of the Tribunal in AYs 2002-03 & 2003-04 is squarely applicable to AY 2005- 06 also. For the reasons stated above, we do not find any merit in ground No. 3 raised by the revenue and accordingly the same is dismissed." 12.5.1 Similar view has been held by the Tribunal in assessee's own case for assessment year 2002-2003 and 2003-2004 in ITA Nos.362 & 363/Bang/2007 (order dated 18-3-2016,). The relevant finding of the Tribunal reads as follows:— '5. Learned AR of the assessee submitted that in the earlier order, though the Hon'ble Tribunal held that provision for warranty was made following scientific method and the past history, still the matter was remanded to the AO for verification. He submitted that when the entire material is on record, it is not in the fitness of things, to remand the matter to the file of the AO. Our attention was drawn to the material on record wherein the methodology and basis of estimating warranty provision was made out which reads as under: "5. Warranty provisioning policy - Methodology and basis of estimating warranty cost: The company has submitted a detailed methodology of estimating the warranty provision before the AO vide its submission on 17-3-2006 for AY 2003-04. An extract of the acknowledged copy of the same is attached herewith as Annexure 2. Please find below a summary of the same: The company has arrived at a model for ascertaining the warranty cost, based on the type of equipment, periodicity of warranty and nature of commitment. The company has a specialized warranty accounting team which tracks the incidents reported of reach product country-wise and associated cost of providing warranty services. The total sales are divided into various categories of IT hardware products based on the warranty periods attached to each such product. The fault are tracked on the basis of a unique identification number attached to each IT hardware so as to identify cases of faults." He also placed a chart in the paper book showing methodology of provision for warranty:

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From the above details, it is clear that provision for warranty is made following scientific method. From the chart it is also clear that as against provision of Rs. 144,114,000/- an amount of Rs. 11,97,00,000/- was utilized in the subsequent year which is almost near the provision. Therefore, it could be easily said that the provision was created based on past history. The methodology followed by the assessee-company cannot be faulted with. Therefore, we direct the A.O. to allow the provision for warranty as a deduction.' 12.5.2 There is no dispute before us that the basis on which the provision of warranty was made in assessment years 2002-2003, 2003-2004 and 2005-2006 as well as in the relevant assessment year is identical. The Tribunal in the above mentioned orders for assessment years 2002-2003, 2003-2004 and 2005-2006 after considering the method of providing for warranty liability by way of a provision, specified that the provisions made was based on past history and was a scientific method of estimating liabilities on account of warranty claims. For the relevant assessment year also, there are automatic reversals of the provision when products goes out of warranty period. For the purpose of estimating the warranty provision, the assessee takes into account only those units in respect of which the warranty period has not expired as on the date of estimation of provision. Accordingly, the system would automatically exclude those products for which the warranty period has expired and include only those products (i.e. products sold in past for which warranty period has not expired and products sold during the year with a warranty

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commitment) for which warranty period has not expired. Thus, based on the above accounting methodology, as the reversals get adjusted with the provision required to be created in the subsequent years, it, in effect, leads to the same being credited to the profit and loss account in the subsequent year. In view of the parity of basis of provision for warranty for assessment years 2002-2003, 2003-2004, 2005-2006 and the relevant assessment year, the ruling of the Tribunal in assessment years 2002- 2003, 2003-2004, 2005-2006 is squarely applicable for this assessment year also. 12.5.3 We noticed in the final assessment order, the A.O. had commented that the ITAT order in assessee's group case, namely, CIT v. Dell International Services India (P.) Ltd. (wrongly mentioned as assessee's group company) has been set aside by the Hon'ble High Court and restored to the Tribunal with a direction to examine the claim of warranty. In this background, it is necessary to recapitulate the background of the Tribunal order for assessment years 2002-2003 and 2003-2004. In the first round, the Tribunal vide its order dated 16-12- 2017 (in ITA Nos.362/Bang/2007 & 363/Bang/2007) dismissing the appeals filed by the Revenue. The said order was challenged by the Revenue before the Hon'ble High Court of Karnataka in CIT v. Dell International Services India (P.) Ltd. [IT Appeal Nos. 448 and 449 of 2008. The Hon'ble High Court of Karnataka vide judgment dated 26-9- 2012, remanded the matter to the Tribunal to decide the issue in the light of Hon'ble Supreme Court's judgment in Rotork Controls India (P.) Ltd. v. CIT [2009] 180 Taxman 422/314 ITR 62 (This is what is referred to by the AO in page 25, para 3 in the assessment order for assessment year 2009-2010). After remand, this Tribunal further remanded the matter to the Assessing Officer vide order dated 13-2-2015. The same was challenged by the assessee before the Hon'ble High Court of Karnataka in Dell International Services India (P.) Ltd. v. Asstt. CIT [2017] 88 taxmann.com 451/[2016] 382 ITR 37 (Kar.), set aside the remand order passed by the Tribunal and directed the Tribunal to decide the matter on merits. Pursuant to the judgment of the Hon'ble High Court of Karnataka dated 3-2-2016, the order dated 18-3-2016 was passed by this Tribunal in ITA Nos. 362 & 363/Bang/2007, dismissing the appeal filed by the Revenue (finding reproduced supra at para 12.5.1). 12.5.4 As regards ITAT's order for assessment year 2005-2006, the issue of provision warrant arose in the Revenue's appeal before this Tribunal in IT(TP)A No. 1838/Bang/2013. Vide order dated 13-10-2017, the

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Tribunal dismissed the Revenue's appeal (finding reproduced supra at para 12.5). In the appeal filed by the Revenue before the Hon'ble High Court of Karnataka against the said order, the Revenue did not raise any ground on provision for warranty (copy of Hon'ble High Court judgment CIT v. Dell International Services India (P.) Ltd. [IT Appeal No. 236 of 2018, dated 9-11-2018] is placed on record). In view of the aforesaid reasoning and following the orders of the Tribunal in assessee's own case for assessment years 2002-2003, 2003-2004 and 2005-2006, we direct the A.O. to allow provision for warranty as a deduction. It is ordered accordingly. 28. We notice that the method of creation of warranty provision has not undergone change and is consistent with what is described in para 12.5.2 of the above order. Respectfully following the decision of the coordinate bench in assessee’s own case we direct the AO to allow the provision made towards warranty. Since we have directed the AO to allow the entire provision made towards warranty, the alternate claim of the ld AR to consider the amount actually spent substantiated by evidences has become academic and does not warrant adjudication.

Disallowance under section 40(a)(ia) of rebates given to customers [Ground No. II(2)] 29. The relevant ground reads as under: –

Disallowance of expenditure u/s 40(a)(ia) - Rebate and “2. Volume discount — Rs. 501,007,784

2.1 The learned AO has erred in disallowing the payment towards Rebate of Rs.501,007,784 under Section 40(a)(ia) without appreciating that the provisions of TDS is not applicable on Rebate provided to distributors working on a Principal to Principal basis. 2.2 Having accepted that the ownership has been transferred to the distributors, the learned AO has erred in stating

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that the ownership of the distributors is temporary. The learned AO failed to appreciate the fact that once the appellant sells the goods, the title is passed on to the distributor and any unsold goods would not be returned to the Company. 2.3 The Honourable DRP has erred in stating that the case laws relied by the appellant are distinguishable from the facts of the present case as in the case laws cited the products transacted were either milk, soft drinks, sim cards etc. which cannot be compared to a laptop or desktop. The Honourable Panel ought to have appreciated that irrespective of the products dealt with, the principal relating to applicability of TDS provisions on Rebate payment should apply.” 30. During the assessment proceedings, the AO called for details of taxes deducted at source on various payments including an amount of Rs. Rs. 50,10,07,784/- was in the nature of rebate given to distributors. The assessee submitted before the AO that taxes were not liable to be deducted at source on the rebate given to distributors. The AO was of the view that the transaction was one between principal and agent and not principal to principal basis and therefore, the assessee is obliged to deduct tax under Section 194H of the Act. Accordingly, the AO made a disallowance of Rs. 50,10,07,784/- under Section 40(a)(ia) of the Act

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provisions of TDS are not applicable. It was further submitted that the Assessee is in the business of manufacture and trading of computers along with related accessories that are sold goods through its distributors by adopting two models for distribution as described under:

A. Bill to Order Under this model, the distributor undertakes to collate orders from the prospective customers on behalf of the Assessee and acts as an agent between the customer and Assessee for which the distributor earns commission at a prescribed rate on every successful order. The Assessee is ultimately responsible for all the risks and reward arising from such orders after the same is accepted. The entire obligation pertaining to fulfilment of orders is on the Assessee and not the distributor. The Assessee deducts applicable taxes at source on such commission paid to the distributors under bill to order model. B. Stock and Sell (SNS)

In this model the distributors purchase final products from the Assessee at its own risk and in turn sell the same to the ultimate customer or a sub distributor at a predetermined price. The title in the goods is passed on to the distributor upon delivery of goods subsequent to sale by the Assessee. It is the responsibility of the distributor thereafter to sell such goods to the consumers and any unsold goods would not be returned back to the Assessee. Further, the distributor shall make the payments in relation to such purchases, within the time prescribed in the agreement irrespective of whether the same is sold by him or not. Further, upon achieving certain predetermined targets as set out by the Assessee, the distributors are eligible for rebate / volume discount at a predetermined rate. Therefore the nature of relationship between the Assessee and the distributors is that of a principal-to-principal and therefore there is no tax is liable to be deducted at source. This is evident from a reading of the agreement at page 2063 of Volume 5.

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- Harihar Cotton Pressing Factory v. CIT (Reported in [1960] 39 ITR 594 (Bombay) - Ahmedabad Stamp Vendors Association v. UOI (Reported in [2002] 124 Taxman 628 (Gujarat)) - CIT v. Ahmedabad Stamp Vendors Association (Reported in [2012] 25 taxmann.com 201 (SC - Bharti Airtel Ltd. v. DCIT (Reported in [2014] 52 taxmann.com 31 (Karnataka) - CIT v. United Breweries Ltd. (Reported in [2017] 80 taxmann.com 123 (Andhra Pradesh and Telangana) - CIT v. Intervet India (P.) Ltd. (Reported in [2014] 49 taxmann.com 14 (Bombay - ACIT v. Acer India (P.) Ltd. (Order dated 05.10.2018 passed by this Hon’ble Tribunal in ITA No. 1940/Bang/2018) 34. The ld. DR relied on the orders of the lower authorities.

“59. We have considered the rival submissions and perused the material on record. The assessee is distributing the products under two models i.e. Sales through distributors who act as agents and gets compensated on a commission basis. The second model is where the products are sold to the distributor and the distributer get a rebate in the products purchased based on the business volume. When the relationship between the assessee and the distributor is on a principal to principal basis, the rebate /volume discount given by the assessee on the price of products sold to distributer cannot be characterized as

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commission in order to attract section 194H of the Act thereby there is no liability to deduct tax at source. We notice that the Hon’ble jurisdictional High Court has expressed a similar view in the case of Bharti Airtel Ltd (supra) where it is held that – 51. From the aforesaid clauses, it is clear that there is no relationship of principal and agency. On the contrary, it is expressly stated that the relationship is that of principal to principal. Secondly the Distributor/Channel Partner has to pay consideration for the Product supplied and it is treated as sale consideration. There is a Clause, which specifically states that after such sale of Products, the Distributor/Channel Partner cannot return the goods to the assessee for whatever reason. It is the Channel Partner and the Distributor who have to insure the products and the godowns at their cost. They are even prevented from making any representation to the retailers unless authorized by the assessee. What is given by the assessee to its Distributor/ Channel Partner is a trade discount. It is not commission. 60. It is the contention of the assessee that the clauses of the agreement with its distributors demonstrate that the transactions in relation to rebate/discount are on a principal-to-principal basis not attracting the provisions of section 194H. We are of the view that the agreements with distributors require examination to verify the claim of the assessee. We therefore remit this issue to the AO for verification of the agreements which the assessee has entered into with the distributors in relation to discount/rebate transactions and decide the allowability based on the ratio laid down by the Hon’ble High Court after giving reasonable opportunity of being heard to the assessee. This ground is allowed for statistical purposes.” 36. Respectfully following the above decision we remit this issue to the AO for verification of the agreements which the assessee has entered into with the distributors in relation to discount/rebate transactions and decide the allowability based on the ratio laid down by

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the Hon’ble High Court after giving reasonable opportunity of being heard to the assessee. This ground is allowed for statistical purposes.

Addition of deferred revenue – Ground No.II(3)

“3. Deferred revenue— Rs. 1,391,721,213 3.1 The learned AO has erred in disallowing an amount of Rs. 1,391,721,213 contending that income has accrued to the appellant during the current financial year and hence, should be assessed to tax during the current year. 3.2 The learned DRP has erred in upholding the action of the learned AO by placing reliance on its directions for AY 10-11. Accrual of income 3.3 The learned AO ought to have appreciated that as the contracts to provide services extend beyond the current year, only the proportionate revenue pertaining to the current year can be assessed to tax. This is also upheld by the appellate authorities in various judicial precedents. 3.4 Further, the learned AO and Honourable DRP ought to have appreciated that the said method of accounting consistently followed by the appellant year-on-year should be accepted. Right to receive 3.5 The learned AO and the Honourable DRP has erred in not appreciating the fact that as per the terms of sale, the customer has an option to cancel the contract and seek refund of money. No cost incurred 3.6 The learned AO has erred in placing reliance on the order for AY 2010-11, wherein it was contended that, the appellant has deferred only the revenue and no corresponding cost has been deferred.

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3.7 He ought to have appreciated the fact that there would be no associated costs (except Software License cost which is deferred) incurred during the current year in respect of services to be rendered in future.

3.8 The learned AO and the Honourable DRP ought to have appreciated that recognizing the entire consideration as income during the current year would tantamount to taxing the gross receipts and not the profits or gains arising from such sale.

3.9 Notwithstanding and without prejudice to the above, we submit that, should the deferred revenue be taxed in the current year, corresponding deduction for the costs to be given in order to tax the net profits and not the gross receipts.

3.10 Notwithstanding the above contention, if the deferred revenue is taxed in the current year, corresponding relief ought to be provided in the subsequent year where the same is offered to tax.” 38. The Assessee is engaged in the business of sale of computer hardware, and also offers warranty service to the customers, which represents a contractual obligation on part of the Assessee to provide services for a defined period for a given consideration agreed. Though the entire sale price for warranty is invoiced to customers along with sale of products during the previous year, the obligation to provide services and the outflow of resources (cost of spares, labour and logistics) would happen over a period of time. Therefore, in line with the matching principles of accounting, the revenue for the same would be recognized proportionately in the year of providing the services.

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Also, following the matching concept, the cost in relation to providing such services would also be recognized in the same year.

• At the outset, it is submitted that the AO erred in proceeding on an erroneous footing that there is no concept of deferment of income as per the Act and contending that the income of Rs. 139,17,21,213/- has accrued to the Appellant during the financial year 2010-11. • It is submitted that the AO ought to have relied on the cancellation policy provided under the terms of warranty wherein the customer has the right to cancel the contract with a prior notice and upon cancellation of the contract, the Assessee has to refund the entire consideration less cost of services already rendered. • In terms of Section 5 of the Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which is received or is deemed to be received in India in such year, accrues or arises or is deemed to accrue or arise to him in India during such year. It is submitted that during the year under consideration, to the extent of Rs. 139,17,21,213/-, no income “accrued” to the Assessee.

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• In the Assessee’s case, as the obligation to provide the warranty services which could involve outflow of resources like goods(spares) and services are yet to occur and hence, in line with the generally accepted accounting principles, revenue is recognized on a straight- line basis over the period of contract. Any portion of consideration for which invoices have been raised but, some portion of the contract period pertains to subsequent year would be classified under “other liabilities” and the same would be recognized as revenue in the year in which obligation to provide the services arise. • To illustrate, say the Company sells a laptop in December 2010 along with warranty for two years. In such a case, proportionate revenue towards warranty services for four months would be accounted in FY 2010-11 and the balance would be carried forward to the next two years and offered to tax based on time proportion. Thus, though the full consideration for providing the service is agreed and received during the FY 10-11, the obligation to service the customer arises over a period of time in FY 10-11 (4 months), 11-12(12 months) and 12-13 (8 months). Thus, the contracts which are extending beyond the current financial year, the consideration towards such contracts should also be assessed to tax on annual basis in which the services are provided. Until such consideration is recognized as revenue, the same shall be classified under other liabilities. • Under the Act, income accrues or arises when the Assessee acquires a right to receive the same. The right to receive is coupled with the liability on the other party to make the payment. In the Assessee’s case, in relation to contracts for services extending beyond the financial year 2010-11 under consideration, the Assessee is under a contractual obligation to render the service to the customer in the subsequent years and the same would involve outflow of cost/resources for the Assessee. Further, in case the contract is cancelled, the Assessee is liable to refund the consideration received originally, less cost of services already rendered. • It is submitted that as and when the services are rendered in a particular year, the revenue deferred to such year is recognized as revenue during such year (amortised) and offered to tax. The movement of deferred revenue is as under:

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Assessment Opening Closing Net debit to Year Balance (under Balance (under Revenue Other Other (P&L) Liabilities) Liabilities) 2010-11 (216,92,03,935) (341,83,99,970) 124,91,96,035 2011-12 (341,83,99,970) (481,01,21,184) 139,17,21,213 • Clearly, the Assessee has been recognizing the revenue periodically on the basis of accrual and offered them to tax. 42. The ld AR also submitted that the issue is squarely covered by the order of this Hon’ble Tribunal in Assessee’s own case for assessment year 2010-11 [order dated 18.08.2022 passed in IT(TP)A Nos. 562 & 400/Bang/2015] at paras 31-35, where the assessee’s ground of appeal was allowed, accepting the above contentions and the addition deleted.

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for outright purchase of services and not an advance to be appropriated against future use of the service. The assessee acquires the absolute right to utilize the amount so received. Thus, the income crystallizes as soon as a customer makes payment. The right to receive the income vests with the assessee as soon as the services are purchased by customers. Since, the assessee employed mercantile system of accounting, income would accrue with receipt and it cannot be considered as advance income, which could be deferred for tax purpose.” 32. However it is submitted that upon cancellation of the contract, the Assessee has to refund the entire consideration less cost of services already rendered. On perusal of a sample warranty terms (pages 2527- 2540, relevant page 2537, Volume 6 of the paperbook) we notice that the assessee would refund the money upon premature cancellation of warranty service. The extract of the clause in the agreement is reproduced below for reference:- “Cancellation. Subject to the applicable product and services return policy for Customer's geographic location, Customer may terminate this Service within a defined number of days of Customer's receipt of the Supported Product by providing Dell with written notice of cancellation. If Customer cancels this Service within that period, Dell will send Customer a full refund less the costs of support claims, if any, made under this Service Description. However, if that period has transpired since Customer's receipt of the Supported Product, Customer may not cancel this Service except as provided by an applicable state/country/province law which may not be varied by agreement. Dell may cancel this Service at any time during the Service term for any of the following reasons:

Customer fails to pay the total price for this Service in accordance with the invoice terms; Customer refuses to cooperate with the assisting analyst or on-site technician; or

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Customer fails to abide by all of the terms and conditions set forth in this Service Description.

If Dell cancels this Service, Dell will send Customer written notice of cancellation at the address indicated on Customer's invoice. The notice will include the reason for cancellation and the effective date of cancellation, which will be not less than me 0-01 days from the date Dell sends notice of cancellation to Customer, unless state law requires other cancellation provisions that may not by varied by agreement. IF DELL CANCELS THIS SERVICE PURSUANT TO THIS PARAGRAPH, CUSTOMER SHALL NOT BE ENTITLED TO ANY REFUND OF FEES PAID OR DUE TO DELL.”

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Volume 6 of the paperbook) that the when the services are rendered in a particular year, the revenue deferred to such year is recognized as revenue during such year (amortised) and offered to tax and therefore it is clear that the Assessee has been recognizing the revenue periodically on the basis of accrual and offered them to tax. 34. The coordinate bench of the Tribunal in the case in Schneider Electric IT Business India Pvt. Ltd. v. JCIT, LTU [ITA Nos. 299/Bang/2014 and 218/Bang/2014) dated 30.04.2019] has considered a similar issue and held that – “91. We have carefully considered the rival submissions. The first aspect which we would like to clarify is that it was not correct on the part of the AO to characterize the sum of Rs.5,38,22,153 as undisclosed income. The income is disclosed in the books of accounts but is not recognized for the purpose of income tax computation because of the Assessee's accounting policy which in turn is based on AS-9 of ICAI. The second aspect which has to be clarified is that the deferment of revenue as not pertaining to the relevant AY 2009-10 is also substantiated by the Assessee and the basis of deferral of revenue is clearly given in paper book no.7 pages 1620 to 1897. Therefore there can be no dispute that the income deferred did not pertain to AY 2009-10, if one were to accept that deferral of income, though it has accrued to an Assessee, is possible. The principal question therefore that needs to be addressed is regarding whether deferring revenue is permissible under the mercantile system of accounting followed by the Assessee where income that accrues or arises to an Assessee has to be regarded as income. 92. The learned counsel for the Assessee in his rejoinder submitted that the decision of the Tribunal rendered in the case of Optum Health & Technology (India) (P.) Ltd. (supra) is clearly distinguishable because in that case not only was the revenue received but also services were rendered and still the Assessee chose to defer revenue recognition and it was in those

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circumstances, the Tribunal held that deferring revenue was not proper and had to be regarded as income of the relevant year. 93. We have given a very careful consideration to the rival submissions. Similar issue had arisen for consideration in the case of Punjab Tractors Co-op. Multipurpose Society Ltd. (supra) before the Hon'ble Punjab & Haryana High Court. In that case the facts were that the assessee was engaged in the purchase and sale of tractors, motor cycles, etc., and doing their repairing. It had received advances from the buyers of tractors to cover their service charges for a period of one year after the expiry of initial warranty period. It had shown same on the liability side in the balance sheet for the assessment year 1978-79 under the head 'Post-Warranty Service Advances' (PWS Advances). It used to make adjustment of the amount received from PWS Advances Account to the Workshop Income Account during the quarter in which the work of repairs and services was done, and included the amount so adjusted as income of the relevant year. Out of the aggregate amount shown in PWS Advances Account, the Assessing Officer treated proportionate sum for the period covered as the assessee's income for the assessment year in question. The Commissioner invoked section 263 and held that the entire amounts received in the previous year towards PWS Advances were trading receipts of the year directly connected with the business of servicing and repairs of tractors. He, accordingly, set aside the assessment. On appeal, the Tribunal upheld the Assessing Officer's action disagreeing with the finding of the Commissioner. On reference, the Hon'ble Punjab & Haryana High Court held as follows: "The taxability of income normally depends upon the system of accounting followed by the assessee. Even in the case of an assessee following the mercantile system of accounting, a mere claim, by the assessee in respect of an amount without the right to claim cannot form the basis for taxability. Where the assessee follows the cash system of

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accounting, the taxability is to be based on receipt basis and not on accrual basis. Receipt, either accrued or deemed, is not made a condition precedent to taxability. Profits or gains are taxable if they have accrued or have arisen or are, under the Act, deemed to have accrued or arisen to the assessee in the accounting year. Generally, income must accrue first, receipt normally follows the accrual. In other words, the right to receive must come into existence before the actual receipt takes place. Receipt, by itself, is not sufficient to attract tax. It is only receipt as 'income' which would attract tax. Every receipt by the assessee is, therefore, not necessarily income in his hands. It bears the character of income at the time when it accrues in the hands of the assessee and then it becomes eligible to tax. What is relevant to determine whether money received is income or simply an advance, is the initial character of the receipt and not the head under which the amount is credited in the books of account. If no income has resulted, it cannot be said that income accrued merely on the ground that the assessee has been following the mercantile system of accounting." The Hon'ble Court accordingly upheld the stand of the Assessee. Holding that the Assessee did not become owner of the money received unless the services are rendered and was not entitled to appropriate the same till service was rendered in lieu of which the same was received in advance. 94. The Hon'ble Madras High Court in the case of Coral Electronics (P.) Ltd. (supra) also dealt with similar case. The assessee is a private limited company carrying on business in television sets. In the previous year ending 31st March, 1983, and 31st March, 1988 corresponding to the assessment years 1983-84 and 1988-89, respectively, the assessee had collected service charges, which were bifurcated into two items, one as pertaining to year and another pertaining to the subsequent assessment year

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and, therefore, excluded from consideration in determining the total income of year. The Assessing Officer treated it as income and taxed the same. The Tribunal has held that it is not taxable income. On a reference the Hon'ble Court held the amount that was received was only as charges for the services to be rendered in future. The services may be rendered or may not be rendered depending upon withdrawal of the money as and when the customer required. So, it is highly uncertain as to whether it would at all remain as income of the assessee. Only when the service is done the assessee has a right over the amount that was deposited. Till then, he has no right over the same. It is in that sense till then, it cannot be considered as an income of the assessee and is not eligible to tax. 95. The Mumbai ITAT in the case of IOT Infrastructure & Energy Services Ltd. (supra) had to deal with identical case. The facts of that case were that the Assessee had not offered for tax an amount being difference between progress billing as on 31-3- 2007 and cumulative revenue booked as per accounts as on 31-3- 2007 in respect of three contracts. The assessee explained to Assessing Officer that progress billing was inclusive of advances received from customers which amount did not reflect work performance. It was also explained that progress billing was done not only for amount of work done but also for mobilisation and other advances receivable by it as per terms of relevant contract and that mobilisation and other advances received by assessee by raising progress billings did not represent income of assessee at time of raising progress bills and same therefore had no effect whatsoever on income of assessee, which was recognised by method of percentage of completion. The Assessing Officer, however, held that amount due to customers as shown by assessee was nothing but understatement of its profits and added same to total income of assessee. On further appeal the question before the Tribunal was as to whether amount due to customers as shown by assessee was nothing but receipt of advance before accrual of income and, therefore, same could not be treated as

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income of assessee at point of receipt. The Tribunal held in favour of the Assessee. 96. As far as the decision of the Tribunal in the case of Optum Health & Technology (India) (P.) Ltd., is concerned, as rightly contended by the learned counsel for the Assessee the facts were that the sums were received in advance and in respect of the sums received services were also performed but still the Assessee did not recognize revenue but postponed recognition based on the bills raised on the clients for services performed. Though there are observations in the order of the Tribunal that postponement of recognition of income is not possible on the basis of AS-9 of ICAI when income accrues or arises under the mercantile system of accounting, those observations have to be confined as decision on the facts of that case. In the light of the decision of the Hon'ble High Courts of Punjab & Haryana and the Hon'ble Madras High Court, we are of the view that the claim made by the Assessee deserves to be accepted. Accordingly the addition made by the AO and confirmed by the DRP is directed to be deleted. Gr.No.19 is accordingly allowed.” 35. In the light of the decision of the coordinate bench of the Tribunal and considering the facts of the case as discussed above, we are of the view that claim of the assessee deserves to be accepted and the addition made by the AO as confirmed by the DRP is hereby deleted. This ground accordingly is allowed in favour of the assessee. 45. Respectfully following the decision of the coordinate bench we hold that the claim of the assessee deserves to be accepted and the addition made by the AO as confirmed by the DRP is hereby deleted. This ground accordingly is allowed in favour of the assessee.

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Disallowance of Marked to Market (MTM) Losses – Ground No. II (4)

“4. Mark to Market Loss (MTM) — Rs. 284,364,000 4.1 The learned AO has erred in disallowing Mark to Market (MTM) loss on hedging transaction amounting to Rs 284,364,000 without appreciating the fact that such losses are incurred to mitigate foreign exchange fluctuation risk in relation to imports and the same is revenue in nature. 4.2 The learned AO has erred in considering the MTM loss as notional/contingent in nature without appreciating that such losses arise out of a contractual obligation existing as of the reporting date and the same cannot be of contingent nature. 4.3 The learned AO has erred in not placing reliance on the judicial precedents quoted by the appellant which deals with issue of MTM loss being ruled in favor of appellant. 4.4 The learned AO has erred in placing reliance on CBDT Instruction 3, 2010 and disallowing the MTM loss without considering the fact that the transaction was for hedging and not for speculative purpose. DRP directions not followed by AO 4.5 The learned AO has erred in not following the directions of the Honourable DRP which has directed to allow the MTM loss if MTM gain was offered to tax in AY 2010- 11. 4.6 Without appreciating that the details of such MTM gain offered to tax was submitted before the officer during the

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assessment proceedings for AY 2010-11, the learned AO has erred in stating that whether the forex gain offered to tax in AY 2010-11 was in the nature of MTM loss/gain or otherwise is not established. 4.7 Notwithstanding the above, in case if the said MTM loss were to be disallowed, reversal, if any, of the said MTM loss in the subsequent year should not be assessed to tax.” 47. During the financial year 2010-11, the Assessee had accounted Rs. 28,43,64,000/- towards loss on marked-to-market derivative contracts entered into by the Assessee to hedge its foreign currency payables in future. The Assessee had entered into forward contracts to hedge a part of its foreign currency payables in future relating to imports amounting to USD 210,000,000 (INR 97,74,53,47,500). As on 31.03.2011, such contracts valued at market price prevailing on that date has resulted in MTM loss amounting to Rs. 28,43,64,000/- which has been debited to profit and loss account.

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section 144C(13) of the Act, no further opportunity could be given to the assessee and the verification of details of earlier years was not possible.

• According to the “Accounting for Derivatives” as issued by the Institute of Chartered Accountants of India (“ICAI”) in March 2008, a company is required to provide for losses in respect of all outstanding derivative contracts as at the Balance Sheet date by marking them to market. The same is in line with the principle of prudence as enunciated in AS-1 “Disclosure of Accounting Policies” issued by the ICAI as well as notified under Section 145(2) of the Act. • The fundamental principle of accrual, as recognized in AS-1, rests on the basic premise of recognition of expenses incurred during the year, even though the same may be discharged at a future date. If the same were to be disregarded and allowed only at the time of settlement, it would amount to rejecting the method of accounting adopted by the Assessee and substituting the same, in part, by cash method which is not justified. • Hence, it is submitted that the recognition of MTM losses in the books of accounts is in accordance with the AS notified under Section 145 of the Act as the above accounting principles of prudence and accrual require accounting for MTM loss as at the Balance Sheet date. • It is submitted that the principles of accounting should be applied for the purpose of ascertaining taxable profits of a business as long as they are not in contradiction with any express provisions of the statute. • It is a settled position that any expenditure not being in the nature of capital or personal expense, and laid out wholly and exclusively for

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the purpose of business or profession carried out by the assessee would be allowable as a deduction. In the present case, the MTM loss having arisen on account of hedging in revenue transactions and not being capital in nature, it is submitted that the same is allowable as business expenditure. • Detailed workings of the losses for every contract entered into along with bank confirmations are furnished before the AO at pages 759 of Volume 2 of paperbook read with pages 789-791 of Volume 3 of the paperbook. • The AO erred in holding that MTM loss is contingent in nature and cannot be allowed to be set off against the taxable income. A contingent debt or liability is one that has no present existence. On the other hand, MTM loss arises out of a contractual obligation existing as on the Balance Sheet date wherein a reliable estimate of the loss occurring form an existing contract is made, though the same is required to be discharged in the future. In view of the same, MTM losses are not inchoate, unascertained or uncertain obligations as on the reporting date. • Therefore, it is submitted that the MTM loss on unsettled forex derivatives as on the Balance Sheet date is not a notional loss and is not contingent in nature and the same is allowable as business expenditure while computing taxable income if the forex derivative was entered into on revenue account and the same has accrued during the year. • It is also submitted that CBDT Instruction No. 3/2010 is not applicable to MTM loss on forward contracts which are for the purpose of hedging the risk. • The Assessee has been consistently following the mercantile system of accounting where all estimated losses and gains arising out of forex transactions are accounted as and when they accrue.

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• For AY 2010-11, the Assessee had a MTM gain of Rs. 9,10,11,994, which was offered to tax by netting off the same against the exchange loss for the year and a net exchange loss of Rs. 15,49,68,827 was debited to the profit and loss account. However, in the draft assessment order passed for the said AY, the AO had disallowed the gross amount of Rs. 24,59,80,821 and thereby accepting the accounting policy and the tax treatment given by the company on gain from MTM contracts amounting to Rs. 9,10,11,994. • Without prejudice, if the MTM loss were to be disallowed, reversal of the said loss in the subsequent year should not be assessed to tax. 51. The ld AR submitted that the issue is covered by the decision of this Hon’ble Tribunal in the Assessee’s own case for AY 2009- 10(Order dated 08.04.2022 passed in M.P. Nos. 22&23/Bang/2022 in IT(TP)A Nos. 130&121/Bang/2014).

We notice that the Tribunal is consistently taking the view that the loss arising on revaluation of outstanding forward contracts entered to safe guard the underlying revenue assets cannot be considered as notional loss and accordingly the same is eligible for deduction while computing total income. The following observations made by the co-ordinate bench in the case of M/s Quality Engineering and software Technologies P Ltd (supra) are relevant:- “4.5.11 As discussed earlier, in the case on hand, there has been an existing contract with a binding obligation accrued against the assessee when it entered into forex forward contracts. The forward contracts are in respect of consideration for export proceeds, which are revenue

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items. There is an actual contract for sale of merchandise. In this factual matrix, it is clear in our view that the transaction in question will not qualify to be called as speculative transaction. In view of the facts and circumstances of the case on hand, as discussed above, we hold that the provision on derivative contracts is allowable as expenditure. We, accordingly allow the Grounds at S. Nos. 1 to 9 raised by the assessee.” The above said decision rendered by the co-ordinate bench states that the loss arising on reinstatement of a forward contract, whose underlying assets is a revenue item, then it cannot be considered as speculative loss and also not a notional loss. In that case, the loss arising on restatement of forward contract is fully allowable as deduction. Accordingly, the AO was not justified in holding that the loss claimed by the assessee is either notional/contingent loss or speculative loss. Since the loss is related to the revenue assets, the same is allowable as deduction. Accordingly, we direct the AO to delete the disallowance of loss of Rs.68.24 crores. 53. Respectfully following the above decision we hold that the MTM loss is related to the revenue assets, the same is allowable as deduction. Accordingly, we direct the AO to delete the disallowance of loss of Rs. 28,43,64,000/- claimed by the assessee. This ground is allowed in favour of the assessee.

Disallowance of expenditure under section 40(a)(ia) of the Act (Ground No. II(5) 54. The relevant ground reads as under –

Disallowance of expenditure u/s 40(a)(ia) of the Act — “5. Rs. 9,468,332

5.1 The learned AO has erred in disallowing an amount of Rs. 3,254,369 without appreciating the fact that details of

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TDS were submitted for a substantial amount of 198.96 crores out of the total disallowance of Rs. 199.29 crores.

5.2 The learned AO has erred in disallowing an amount of Rs. 6,213,963 out of the deduction claimed under section 40(a)(ia) of the Act during the current year without appreciating the fact that that details of TDS were submitted for a substantial amount of 27.51 crores out of the total disallowance of Rs. 28.13 crores.” 55. During the course of assessment, the AO called for details of repairs and maintenance charges, sub-contracting charges and advertisement charges paid, along with details of tax deduction at source. Out of the total expenses debited of Rs. 199,29,17,376/, the assessee has provided evidence of TDS/ TDS not applicable for substantial sum of Rs. 198,96,59,335/-. However, for certain expenses as listed below, considering the volume of transactions, the assessee had not submitted the details of TDS and the AO made a disallowance of Rs. 32,54,369/- for want of evidence.

Nature of Amount debited Evidence for Difference expense (INR) TDS given (INR) (INR) Repairs & 17,26,42,144/- 17,12,73,102/- 13,69,042/- Maintenance Sub-contracting 66,23,06,308/- 66,09,18,054/- 13,88,254/- charges Advertisement 31,40,80,812/- 31,35,83,739/- 4,97,073/- Total 32,54,369 56. In the return of income, the assessee also claimed allowance of an amount of Rs. 28,13,64,044/- u/s.40(a)(ia) and the details pertaining to the same were also called for by the AO. The AO disallowed an amount of Rs. 62,13,963/- out of the deduction claimed under section

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40(a)(ia) of the Act on the ground that the details of TDS were not furnished for the same.

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the evidences. We also notice that the Mumbai Bench of the Tribunal in the case of M/s Infinity Retail Limited vs ACIT (ITA No. 7718/MUM/2012 dated 13.10.2022) has considered a similar issue and held that –

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by the Ld. Authorised Representative for the Appellant that the Appellant has substantially complied with the directions given by the Assessing Officer and therefore, in our view, the TPO/Assessing Officer was not justified in making additions of INR 42,40,116/-. Further, in our view, the TPO has also failed to determine the ALP of the transaction and has, in effect, made disallowance holding that the Appellant had failed to substantiate the claim. Accordingly, in view of the aforesaid, we delete the addition of INR 42,40,116/-. Ground No. 2.3 raised by the Appellant is allowed. 60. For a company of assessee’s size and the volume of business, assessee has managed to submit more than 95% of the supporting documents with respect to the expenses claimed. It is also to be noticed that the AO has not found any discrepancy with respect to TDS compliance in the bills/evidences submitted and has fully allowed to the extend the supporting documents are submitted. Considering the above fact of the case and the decision of Hon’ble Tribunal in the case of M/s Infinity Retail Limited (supra) we of the considered view that the assessee should be allowed full deduction of these expenses basis that more than 95% of the details are submitted and no discrepancy is found on the same. We therefore direct the AO to delete the additions. This ground is allowed in favour of the assessee.

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IT(TP)A No.641/Bang/2016 (Revenue’s appeal)

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23.5 We have heard rival submissions and perused the material on record. The net forex loss arising after set-off of the said gain on forward contract is as under: Nature of forex loss Amount (in Rs.) Gain on forward exchange contracts (5,26,74,967) Realised and unrealized forex loss (Net) – on 116,36,27,892 settlement/re-statement of forex transaction Amount claimed as deduction 111,09,52,925

23.5.1 The AO’s observation that the assessee had not offered any gain to tax is ex facie incorrect. AS-11 requires a foreign currency transaction to be initially recognized using the exchange rate as on the date of the transaction. However, at each balance sheet date, the foreign currency monetary items would be required to be reported using the

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closing rate. Such exchange loss accrued as at the year-end is in accordance with the method of accounting regularly adopted by the assessee and is not notional or contingent in nature. Before the AO, the assessee had submitted the following:

 ledger extracts showing the accounting entries for forex gain/loss for the financial year 2008-09;  Sample invoices  the process adopted in accounting the forex gain/loss for each of the foreign currency transaction;  voluminous back-up workings including monthly Foreign Currency Trial Balance substantiating the net forex gain or loss booked in the forex ledger extracts;  Sample copies of intercompany summary extracts showing the invoice value in foreign currency for various transactions etc.

23.5.2 The AO completely ignored the detailed workings on forex loss. Having mentioned in the order that sample invoice copies were submitted, the AO erred in contending that no evidences were provided by the assessee. The DRP rightly appreciated that evidences demonstrating foreign exchange loss had been submitted and that the same cannot be said to be contingent liability. Therefore, ground 5 is dismissed. 23.5.3 68. It is noticed that in the year under consideration the assessee has made relevant submissions in this regard before the AO at page 565- 557 of Volume 2 of paper book. Therefore respectfully following the decision of the coordinate bench in assessee’s own case for AY 2009- 10 we dismiss the ground of revenue.

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Pronounced in the open court on this 11th day of November, 2022.

Sd/- Sd/-

( GEORGE GEORGE K. ) ( PADMAVATHY S. ) JUDICIAL MEMBER ACCOUNTANT MEMBER

Bangalore, Dated, the 11th November, 2022. /Desai S Murthy / Copy to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. By order

Assistant Registrar ITAT, Bangalore.