M/S CONTINENTAL AUTOMOTIVE COMPONENTS INDIA PRIVATE LIMITED ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-2(1)(1), BANGALORE

Per N. V. Vasudevan, Vice President :

This is an appeal by the assessee against the final Order of Assessment dated 30.11.2018, under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (hereinafter called ‘the Act’), passed by ACIT, Circle – 3(1)(1), Bengaluru, in relation to Assessment Year 2014-15.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 2 of 97 3. In the Manufacturing Segment, the assessee manufactures intermediate products that fall under the product classification automotive components/auto anciliary products like It operates in the following segments: -Instrument clusters; -Engine systems; -Immobilisers and transponders -Speed sensors, -Airbag controllers - Anti-lock braking systems(ABS) -Fuel supply modules; and -Temperature gauges, pressure gauges, etc.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 3 of 97 as to its AEs. For sales to third parties the price is driven by market conditions and for sales to AEs, it is based on agreed pricing policy.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 4 of 97 • Section 92(l) of the Act provides that any income arising from an "international transaction" shall be computed having regard to the arms length price. The Explanation to the said section provides that allowance for any expense or interest arising from an international transaction hall also be determined having regard to the arm' s length price. • The term "international transaction' has been defined in section 92B(1) or the Act to mean a transaction between two or more "associated enterprises" either or both of whom are non-residents in the nature of inter alia purchase, sale or lease of intangible property or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises. • Section 92A of the Act defines the term "associated enterprise" in relation to another enterprise, in a manner where the enterprise directly or indirectly participates in the Management, control or capital of the other enterprise. • The term "arm's length price" (ALP) has been defined in clause (ii) of section 92F of the Act, to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. Section 92C(1) of the Act provides that the arm's length price in relation to an international. By virtue of the provisions of section 92CA(1), the Assessing Officer, with the previous approval of the Pr Commissioner / Commissioner is empowered to refer to the Transfer Pricing Officer (TPO) the computation of the arm’s length price of an international transaction or specified domestic transaction entered into by an assessee over whom the Assessing Officer exercises jurisdiction. The TPO, after due enquiry and opportunity of being heard, shall by order in writing determine the ALP in relation to the international transaction in accordance with provisions of section 92CA(3) and send a copy of his order to the Assessing Officer (AO) and to the assessee for finalization of assessment order. Section 92C(2) provides that the variation between the ALP and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been under taken shall be deemed to be the ALP.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 5 of 97 The AO passes a draft order of assessment against which, the Assessee has a right to file objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. Under section 144C(5), the Dispute Resolution Panel (DRP) shall issue the directions, as it thinks fit, for the guidance of the AO to enable him to complete the assessment after considering report of TPO. The AO passes a final assessment order on the basis of directions of the DRP.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 6 of 97 11. In the course of assessment the Assessing Officer (“AO”) made a reference to the TPO for examination of the arm’s length price of the aforesaid transactions.On such reference, the TPO passed an order dated 30.10.2017 under Section 92CA of the Income-tax Act, 1961 (“the Act”) determining the TP adjustment with respect to manufacturing segment and SWD services segment totaling to Rs.155,70,82,500/-.Initially, a draft assessment order dated 08.12.2017 came to be passed by the AO in which, inter alia, the aforesaid TP adjustment was incorporated, apart from the additions made to the income of the assessee on account of disallowance of provision for warranties and annual license fees. Aggrieved, the assessee filed its objections before the DRP which, vide its directions dated 10.01.2018, rejected most of the assessee’s objections insofar as the TP adjustments made by the TPO were concerned. Pursuant to the directions of the DRP, the AO passed the final assessment order dated 30.11.2018 in which the TP adjustment was reworked to Rs. 143,30,70,101/-.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 7 of 97 manufacturing segment of the Assessee pursuant to the DRP directions.\ (ii) TP adjustment of Rs.25,95,18,911/- made by the TPO in respect of the software development services (‘SWD services’ for short) rendered by the Assessee pursuant to the DRP directions. (iii) Disallowance of provision for warranty to the extent of Rs. 3,21,32,433/-. (iv) Disallowance of annual license fees amounting to Rs. 28,00,21,116/- . (v) Non-set off of brought forward losses amounting to Rs. 232,54,55,699/- available to the Assessee. We shall take up for consideration, the issues as listed above for consideration in seriatim. TRANFSER PRICING ADJUSTMENT IN THE MANUFACTURING SEGMENT: 14. As far as the issue of determination of ALP in the Manufacturing segment are concerned, the facts are that the Assessee filed a Transfer Pricing Study (TP Study) in terms of Sec.92D of the Act justifying the price it received from the AE. The Assessee chose Transactional Net Margin Method (TNMM) – as the Most Appropriate Method for comparing Assessee’s profit margin with that of comparable companies. Under this method the comparison is made between the Assessee’s the operating/ net margins with that of comparable companies to analyse if the related party transactions have been undertaken on an arm’s length basis. Rule 10B(1)(e) of the Income Tax Rules, 1962 (Rules), explains transactional net margin method as a method by which,— (i) the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 8 of 97 employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; Report this ad (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transactionand the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 9 of 97 customs duty adjustment and (iii) a sum of Rs. 23,43,61,607/- towards extraordinary expenses on account of Exchange fluctuation. Due to the above adjustment, the net profit margin as computed by the Assessee in its transfer pricing study and the net profit margin as computed by the TPO varied and consequently, the addition to the total income on account of determination of ALP stood enhanced. This is the major dispute between the Assessee and the Revenue as to how to compute the net profit margin. On making the above mentioned adjustments, the Assessee arrived at a margin of 2.38%. as against - 16.78% arrived at by the TPO. Besides the above, the Assessee also disputes, inclusion of certain companies as comparable with the Assessee by the TPO and exclusion of a company chosen by the Assessee as a comparable company in its TP study. Besides the above, the Assessee has also raised a contention that the provisions of Sec.92 of the Act have to be applied only to the proportionate value of international transaction i.e., transaction with the AE and transactions with non AEs should be not considered for the purpose of adjustment u/s.92 of the Act.

As per the TP study:

Operating Income Rs. 5,17,71,00,000/- Operating Cost Rs.5,05,41,30,000/- Operating Profit (Op. Income – Op. Cost) Rs. 12,29,70,000/- Net mark-up (OP/OR) 2.38%

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 10 of 97 As reflected in the TP Order:

Operating Income Rs. 5,17,71,00,000/- Operating Cost Rs.6,04,57,20,000/- Operating loss (Op. Income – Op. Cost) Rs.-86,86,20,000/- Net mark-up (OP/OR) -16.78%

Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator OP/OR OP/OR (PLI) Database used PROWESS & PROWESS &Ace- CAPITALINE PLUS TP Comparables selected 6 11

Step Description 1. Companies for which data available was for a period prior to 31.03.2012 – rejected 2. Companies reporting net sales >Rs. 1 crore – selected 3. Companies reporting average manufacturing income/average net sales>50% - selected 4. Companies with related party transactions less that 10% of sales – selected 5. Companies with positive net worth – selected 6. Companies which were functionally comparable – selected

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 11 of 97 4. Comparables selected by Assessee and their arithmetic mean:

Sl. No. Name of the company Average OP/Sales(in %) 1. Automotive Stamping Assembly Ltd 1.22 2. Bharat Gears Ltd 4.78 3. Hindustan Hardly Spicer Ltd 4.12 4. JMT Auto Ltd 7.84 5. Munjal Showa Ltd 5.25 6. Wheels India Ltd 5.74 Arithmetical Mean 4.82

The TPO accepted 4 companies selected by the Assessee in its TP study viz., Automotive Stamping Assembly Ltd, Bharat Gears Ltd, JMT Auto Ltd and Wheels India Ltd.

Sl. Name of the Company OP/Sales(in No. %) 1 Rajsriya Automotive Inds. Pvt Ltd 13.07 2 TVS Upasana Ltd 12.13 3 Aspee Springs Ltd 11.15 4 Supreme Treon Pvt Ltd 7.37 5 JMT Auto Ltd 6.46 6 Aditya Auto Products &Engg. (India) Pvt Ltd 5.48 7 Varroc Engineering Pvt Ltd 5.16 8 Leewon Precision Pvt Ltd 4.34 9 Borgwarner Morse TEC Murugappa Pvt Ltd 12.45 10 Maco Pvt Ltd 2.59

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 12 of 97 11 Vijayashree Autocom Ltd 2.20 AVERAGE MARK-UP 7.49

A. Arm’s Length Mean Mark-up 7.50% Operating cost Rs. 604,57,20,000 A. Operating Revenues Rs.517,71,00,000 B. Arm’s length Operating profit (7.50% of Rs.517.71 Rs. 38,82,82,500 C. cr) Arm’s length Cost (B-C) Rs. 478,88,17,500 D. Shortfall being adjustment u/s. 92CA Rs. 125,69,02,500

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 13 of 97 the Assessee pointed out that in the manufacturing segment, the Assessee is in charge of conceptualization and designs. It procures equipment for manufacture both fixed and capital equipments. It owns any intellectual Property rights (IPR) for the products developed by them. It receives technology and manufacturing know-how from it’s Associate Enterprise (AE) for its manufacturing process. It purchases raw materials and components from both third parties and AEs. The nature of raw materials purchased from the AEs and third parties are different. The raw materials procured from the AE are globally sourced by Continental group wherein prices are negotiated globally to get price advantage for bulk purchases. Manufacturing and assembly of products is undertaken by the Assessee. The Assessee receives guidance from its AEs on the quality control procedures to be followed. The Assessee sells finished products to third parties as well as to its AE. Majority of the sales are to OEMs. Continental Group has a Global Key Key Accounts Management (KAM) structure through which it maintains customers relationship with OEMs having global presence which helps the Assessee to establish customer relationship with the Indian entities of global OEMs. The Assessee sells goods both to independent third parties as well as to its AEs. It can be seen from the aforesaid sentences in bold and underlined that the component of AE transaction in the Assessee in the manufacturing segment is only in respect of purchase of raw materials, getting technical know how for which the Assessee pays royalty, getting services specific and getting benefit of shared services and obtaining production support services. The ALP has to be determined only with reference to that proportion of the transaction in which the AE’s are involved and the entire manufacturing segment cost base cannot be the subject matter of determination of ALP. The figures given by the Assessee in this regard were as follows:

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 14 of 97 18A. The percentage of international transacitons to the total operating cost would be at 22.49%, as demonstrated below and therefore, the adjustment if any should be restricted to such percentage alone. Particulars As per TP order Transfer pricing Adjustment 125,69,02,500 (which was reduced by Rs.27,63,35,693 being the payment of royalty by the Assessee to its AE to avoid double taxation) and the final figure of addition was Rs.8,05,66,807) Total operating cost 6,04,57,20,000 Purchase of raw materials 76,47,58,690 Payment of technical know-how 14,89,99,314 Payment of royalty 27,63,35,693 Payment of services availed 17,07,549 Payment of shared services availed 13,40,30,481 Payment for production support 3,37,97,500 services availed Total value of international 1,35,96,29,227 transactions in the manufacturing segment Percentage of international 22.49% transactions to total operating cost Revised transfer pricing adjustment 26,39,21,336 restricted to percentage of international transactions Relief from original adjustment 90,96,29,854 The above plea was not accepted by the TPO. No specific discussion is there on this issue in the order of the TPO.

18B. Aggrieved by the aforesaid determination of ALP by the TPO in the draft order of Assessment by the AO, the Assessee filed objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. The DRP issued directions, whereby it upheld the contentions of the TPO, subject to the following directions:

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 15 of 97 (i) Company Hindustan Hardy Spicer Limited to be included in the list of comparable companies. (ii)The TPO to examine the claim of the Assessee that Supreme Treon Private Limited and Borg Warner Morse TEC Murugappa Pvt Ltd fail the RPT filter. (iii) Re-computation of margins for Vijayashree Automotive Ltd (iv) The rectification petition filed by the Assessee to be considered on merits.

(i) That the DRP erred in not granting an adjustment for underutilisation of capacity (Ground No. 9).

(ii) That the DRP erred in not granting adjustment towards custom duty expenses.(Ground No. 10).

(iii) That the DRP erred in not granting adjustment towards exchange fluctuations.(Ground No. 11)

(iv) The DRP erred in not granting depreciation adjustment (Ground No. 12)

(v) That the DRP erred in upholding the inclusion of Rajsriya Automotive Inds. Pvt Ltd., TVS Upasana Ltd., Aspee Springs Ltd., Supreme Treon Pvt Ltd., Leewon Precision Pvt Ltd., Borgwarner Morse TEC

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 16 of 97 Murugappa Pvt Ltd., and Maco Pvt Ltd. as comparable to the Assessee(Ground No. 13).

(vi) That the DRP erred in not including Munjal Showa Ltd as a comparable to the Assessee. (Ground No. 15)

(vii) That in any event, the DRP ought to have appreciated that adjustment if any, should be restricted to the proportionate value of the international transactions of the Assessee. (Ground no. 16)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 17 of 97 comparable companies has not been considered. According to the AO in terms of Rule 10B(1)( e) clause (iii) the net profit margin arising in comparable uncontrolled transactions has only to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market and the Assessee’s margin can never be adjusted. The TPO held that the data considered by the Assessee to compute the adjustment pertained only to 3 out of 7 companies and that the capacity utilisation for FY 2010 to 2014 alone were considered. It was also observed that under-utilization of capacity is not only for the Assessee but had affected the entire industry. Therefore, its comparable companies also have the same effect as the Assessee. Normally, utilization of capacity is significantly different between the Assessee and comparable companies in the initial stage of operation. However, the Assessee is not in the initial stage of operation.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 18 of 97 the uncontrolled transaction, that is, comparable companies and not to the 'tested party' whose transaction is being compared. It was submitted that the adjustment can be made either in the case of the 'tested party' or the comparable companies so that the difference which could materially affect the amount of net profit margin is removed. More so, in practical situations there may be absence of reliable data in the case of the comparable companies for which such material difference is to be analysed or examined. In certain cases there may arise some difficulty when the reliable data for particular cost or profit may not be available, therefore, a reasonable accurate adjustment in the hands of the tested party may throw fruitful result. This view has been upheld by the ITAT in the case of Pangea3 & Legal Database Systems Pvt Ltd v. Income-tax Officer reported in[2017] 79 taxmann.com 303 (Mumbai - Trib.). This Hon’ble Tribunal has also allowed adjustments in the case of tested party in the following cases:

 Skoda India Pvt. Ltd. v. ACIT reported in [2009] 30 SOT 319 (Pune)  Kirloskar Motors Pvt. Ltd. v. ACIT reported in [2012] 28 taxmann.com 293 (Bangalore)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 19 of 97 Industry (“FICCI”) survey report. Hence principally capacity utilization adjustment should have been granted.

 Global Vantedge P. Ltd. v. DCIT reported in [2010] 37 SOT 1 (DELHI)  ITO v. CRM Services India (P) Ltd reported in [2011] 14 taxmann.com 96 (Delhi)  CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay).  Transwitch (India) Pvt. Ltd. v. DCITreported in [2012] 21 taxmann.com 257 (Delhi - Trib.)  Capgemini India Private Limited v. ACIT reported in [2013] 33 taxmann.com 5 (Mumbai - Trib.)  ACIT v. Fiat India (P.) Ltd. [IT Appeal No.1848 (Mum) of 2009, dated 30-04-2010]  Amdocs Business Services (P.) Ltd. v. DCIT reported in [2012] 26 taxmann.com 120 (Pune)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 20 of 97 contentions have been upheld by this Hon’ble Tribunal in the case of IKA India Private Limited v. ACIT reported in [2019] 101 taxmann.com 276 (Bangalore).

“24. We have heard both the parties and perused the material on record. In this case, the exact details of capacity utilisation of comparable companies was not made available to the TPO. It was alleged that the TPO should obtained it by exercising his powers u/s. 133(6) of the Act so as to compare the capacity utilisation of the comparables with the assessee company. In our opinion, it is appropriate to remit the issue relating to adjustment on account of capacity utilisation of the assessee to the file of the AO/TPO for deciding the same afresh keeping in view the OECD guidelines. If the exact details of capacity utilisation of comparable companies are not available in the public domain, the AOITPO is directed to obtain the same directly from the comparable companies and decide theissue afresh, after affording opportunity of being heard to the assessee. Accordingly, this issue is remitted to the AO/TPO.”

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 21 of 97 32. As far as Grd.No.10 raised by the Assessee is concerned, the same is in relation to adjustment to the cost base of the Assessee on account of custom duty. The Assessee has incurred significant customs duty charges which are proportionately much greater than that of the comparable companies leading to a lower profitability for the Assessee. The comparable companies have not incurred any significant custom duty expense as they primarily manufacture using materials available indigenously within India. It was submitted that the Assessee is still in the process of localizing its manufacturing process. To meet the quality standards and to overcome technological challenges, the Assessee imports raw materials from its AEs. Therefore, it becomes necessary for the Assessee to import raw materials from its AEs which is not the case for the comparable companies, thus, putting the Assessee in a comparative disadvantage viz-a-viz the comparables. The TPO rejected the adjustment sought for the reason that the decision to import is a conscious decision taken by the Assessee and in the absence of any external factors , beyond the control of the Assessee necessitating imports, no adjustment can be made. The DRP upheld denial of such adjustment holding that price increase on account of imported raw material is also to correspondingly take place. It was suibmitted that the import of raw materials is not a commercial decision but on the other hand is necessitated for reasons beyond the Assessee’s i.e., by lack of capacity to localize the procurement which the Assessee is still in the process of doing. Reliance was placed on the following decisions in support of the Assessee’s contentions:

 Skoda India Pvt. Ltd. v. ACIT reported in [2009] 30 SOT 319 (Pune)  Putzmeister Concrete Machines Private Limited v. DCITreported in [2014] 49 taxmann.com 436 (Panaji - Trib.)  Toyota Kirloskar Motors Pvt. Ltd. v. ACIT reported in [2012] 28 taxmann.com 293 (Bangalore)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 22 of 97 33. In this connection, the Assessee’s import consumption vis-à-vis the imports of comparable companies selected by the learned TPO and the Assessee are as below for the FY 2013-14:

Import/Total TPO’s comparables Import/Sales purchases Rajsriya Automotive Inds. Pvt. Ltd. 0.06% 0.03% TVS Upasana Ltd. 1.24% 0.48% Aspee Springs Ltd. 4.46% 2.23% Supreme Treon Pvt. Ltd 7.47% 3.84% JMT Auto Ltd 6.21% 3.26% Aditya Auto Products &Engg. (India) Pvt Ltd. 19.75% 10.25% Varroc Engineering Pvt Ltd. 7.56% 4.80% Leewon Precision Pvt. Ltd. 2.02% 1.05% Borgwarner Morse TEC Murugappa Pvt. Ltd. 0% 0% Maco Pvt. Ltd 64.88% 40.02% VijayshreeAutocom Ltd. 0% 0% Average Import Consumption 10.33% 6.00%

“30. This issue came up for consideration before the Chennai Tribunal in the case of Gates Unitta India Company (P.) Ltd. v. DCIT, 84 taxman.com 69 wherein it was held as follows:-

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 23 of 97 "5. Before us, Id. A.R submitted that 90% of the raw materials of the assessee are' imported as such customs duty adjustments to be made and it includes Rs. 4.31 crores pertained to the customs duty in the manufacturing segment. In principle the customs duty adjustments is allowed in view of the Co-ordinate Bench decision in the case of Motonic India Automotive (P.) Ltd. v. Assn. CIT [20161 73 taxmanri.corn 235 (Chennai Trib.) wherein held that: '6.1 At this stage, it is pertinent to mention the finding of the Pune Bench in the case of Demag Cranes & Components (India) Pvt. Ltd. v. DCIT (supra) dated 4.1.2012 in ITA No.120/PN/2011, which is as follows :

"37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). it is relevant mentioned that we have already analysed the relevant provisions of Income Tax rules vis a vis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of the 'working capital'. in principles, our findings on the issue remain applicable to the adjustments on account of the import cost mentioned in ground 4(b) too. The difference between the AL Margin before and after the said adjustments on account of 'import cost' works out to 0.57% (7.18%-6.61%). Revenue has not disputed the said working of the assessee. In these factual circumstances and in the light of the scope of adjustments discussed above, in our opinion and in principle, the assessee should win on this ground too. One such decision relied upon by the assessee's counsel supports our finding relates to the decision of this bench of the Tribunal in the case of SkodaAuto India p Ltd 122 TT.I 699 (Pune) dated March 2009 wherein, it is held (in para 19 of the order) that,- "No doubt , a higher import content of raw material by itself does not warrant an adjustment in operating margins, as was held in Sony India (P) Ltd.'s case (supra), but what is to be really seen is whether this high import content was necessitated by the extraordinary circumstances beyond assessee's control. As was observed by a Co-ordinate Bench of this Tribunal in the case of E-Gain Communication (P) Ltd. (supra) "the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the open market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect". We do not agree with the AO that every time the assessee pays the higher import duty,

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 24 of 97 it must be passed on to the customers or it must be adjusted for in negotiating the purchasing price. All these things could be relevant only when higher import content is a part of the business model which the assessee has consciously chosen but then if it is a business model to import the SKD kits of the cars, assemble it and sell it in the market, that is certainly not the business models of the comparables that the TPO has adopted in this case. The adjustments then are required to be made for functionally differences. The other way of looking at the present situation is to accept that business model of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments are thus required either way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison possible. The assessee cannot be expected to get the details and particulars which are not in publicdomain. In such a situation, i.e. when information available in public domain is not sufficient to make these comparisons possible, it is inevitable that some approximations are to be made and reasonable assumptions are to be made. The argument before us was that it was first year of assessee's operations and complete facilities ensuring a reasonable indigenous raw material content was not in place. The assessee's claim is that it was in These circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car vas computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were before any of the authorities below. What was argued before the AO was mere fact of higher costs on account of higher import duty but then this argument proceeded on the fallacy that an operating profit margin for higher import duty is perrnissible merely because the higher costs are incurred for the inputs. That argument has been rejected by a Co-ordinate Bench and we are in respectful agreement with the views of our esteemed colleagues. 17-25 additional argument was not available before authorities below and it will indeed be unfair for us to adjudicate on this factual aspect without allowing the TPO to examine all the related relevant facts. We, therefore, deem it fit and proper to remit this matter

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 25 of 97 to the file of the TPO for fresh adjudication in the light of our above observations."

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 26 of 97 adjustment and the DRP upheld the same. The observations of the TPO/DRP and the Assessee’s submission as regards the same was as under:

TPO/DRP observations Assessees submissions The Assessee has already included  Forex fluctuation computed as Foreign exchange gain/loss in its per Accounting Standards (“AS”) income statements and hence, it is 11 takes into account the not appropriate to adjust it for realization loss/gain (fluctuation transfer pricing analysis. due to differences between invoice and payment exchange The Assessee imports components rates) and revaluation loss/gain and raw materials in Euro, US (translation of closing balances at dollars and JPY but sells them in the year-end exchange rate). Indian Rupees and does bear the Hence such exchange fluctuation risk of foreign exchange does not take into account any transaction. The Assessee’s loss is adverse exchange fluctuation due mainly due to higher import cost to depreciation of Indian of raw materials currency on a year-on-year basis. While the Assessee’s submission  The Assessee bears the forex risk talks about review and revision of and hence it has incurred high rate contract with its unrelated forex fluctuation loss which is customers, it does not talk about embedded in the raw material review/revision with AEs and the import cost. The fact that forex Assessee should have revised the risk is borne by the Assessee same considering the foreign cannot be a valid reason for exchange market and depreciation rejecting the adjustment claimed of Indian rupee. by it. Such adjustments are to be  As the Assessee bears the forex conducted not to the Assessee’s risk, any adverse fluctuation on profit but to comparable foreign currency would be borne companies’ profit. only by the Assessee. The AE has nothing to do whatsoever with this Indian leg of the transaction. The Assessee failed to demonstrate Such fluctuation being due to that there exists such losses in the external factors, there would be case of comparable companies no reason for the AE to revise its selected by the Assessee. rate contracts where components have been sold broadly at consistent prices (in some cases

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 27 of 97 even at lower prices). It is to be noted that there has been an extraordinary and significant depreciation in INR over Yen/USD during the year when compared to the previous years.  From a harmonious reading of the relevant provisions of Indian TP Regulations, it is evident that for a comparability analysis of an international transaction with the uncontrolled transaction, reasonable and accurate adjustment is permitted to eliminate any difference which materially affects the price or costs or the profit arising from such transaction in the open market. Nowhere the relevant rules suggest that such adjustment should be made only to the uncontrolled transaction, that is, comparable companies and not to the ‘tested party’ whose transaction is being compared. The adjustment can be made either in the case of the ‘tested party’ or the comparable companies so that the difference which could materially affect the amount of net profit margin is removed. More so, in practical situations there may be absence of reliable data in the case of the comparable companies for which such material difference is to be analyzed or examined. In certain cases there may arise some difficulty when the reliable data for particular cost or profit may not be available, therefore, a reasonable accurate adjustment in

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 28 of 97 the hands of the tested party may throw fruitful result. The Assessee’s profitability is significantly impacted as a result of forex fluctuation where it had import content of around 73% unlike comparable companies with significantly lower portion of import of materials (4%). Hence such losses would not exist in the case of comparable companies.

% Average Euro to Financial year depreciation/ depreciation/ INR rate appreciation appreciation 2008-09 65.45 2009-10 67.37 2.94% 2010-11 60.06 (10.85%) 2.03% 2011-12 66.29 10.37% 2012-13 70.03 5.64% 2013-14 80.66 15.18% 15.18% 2014-15 78.15 (3.11%) 2015-16 71.78 (8.15%) (1.68%) 2016-17 73.77 2.77%

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 29 of 97 2017-18 75.08 1.77%

% Average USD to Financial year depreciation/ depreciation/ INR rate appreciation appreciation 2008-09 46.48 2009-10 47.67 2.57% 2010-11 45.51 (4.54%) 4.11% 2011-12 47.86 5.16% 2012-13 54.19 13.23% 2013-14 60.33 11.34% 11.34% 2014-15 61.03 1.15% 2015-16 65.36 7.10% 2016-17 67.12 2.68% 1.75% 2017-18 64.48 (3.94%)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 30 of 97 As stated above, the Assessee imports a considerable amount of raw materials for undertaking the manufacturing operations in India unlike the comparable companies selected in the transfer pricing documentation by the Assessee and also the comparable companies selected by the learned TPO.It was submitted that in comparison to the Assessee, the comparable companies who are established players in the automobile market, have negligible import content due to indigenization of materials required for production. The Assessee contends that due to stricter quality norms and necessity for adherence to the global quality standards, the Assessee had to import from its group affiliates/foreign unrelated suppliers and therefore localisation of such high quality raw materials had not occurred during the assessment year in question due to several factors.In this connection, the Assessee’s import consumption vis-à-vis the imports of comparable companies selected by the learned TPO and the Assessee are as below for the FY 2013-14:

Import/Total TPO’s comparables Import/Sales purchases Rajsriya Automotive Inds. Pvt. Ltd. 0.06% 0.03% TVS Upasana Ltd. 1.24% 0.48% Aspee Springs Ltd. 4.46% 2.23% Supreme Treon Pvt. Ltd 7.47% 3.84% JMT Auto Ltd 6.21% 3.26% Aditya Auto Products &Engg. (India) Pvt Ltd. 19.75% 10.25% Varroc Engineering Pvt Ltd. 7.56% 4.80% Leewon Precision Pvt. Ltd. 2.02% 1.05% Borgwarner Morse TEC Murugappa Pvt. Ltd. 0% 0% Maco Pvt. Ltd 64.88% 40.02% VijayshreeAutocom Ltd. 0% 0% Average Import Consumption 10.33% 6.00%

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 31 of 97 Import/Total Assessee’s comparables Import/Sales purchases Automotive Stampings & Assemblies Limited 0.93% 0.73% Bharat Gears Limited 0.85% 0.46% Hindustan Hardy Spicer Limited 0.52% 0.29% J M T Auto Limited 6.21% 3.26% Munjal Showa Limited 8.03% 6.37% Wheels India Limited 5.34% 4.15% Average Import Consumption 3.65% 2.54%

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 32 of 97 foreign exchange to customers as it operates in the competitive environment of the automobile industry.On an analysis carried out to determine the change in selling price per unit of the products to the customer across years, it was also observed that there was no significant increase in the selling price of the Assessee to its customers in majority of products. From the same it is evident that the Assessee is unable to negotiate for an increase in sale prices to account for the impact of forex fluctuations etc.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 33 of 97 44. The above exercise was carried out for FY 2013-14 and it was observed that majority of the components imported by the Assessee did not result in higher per unit price when compared with the previous year. In fact, in majority of cases, the per unit price has only declined/stayed constant. This demonstrates that the foreign exchange rate fluctuation is the lone factor that has significantly contributed towards higher import cost of the Assessee in turn affecting its profitability.Out of the total imports, INR 2,009.62 million pertained to import of components that were common for both FY 2013-14 and FY 2012-13. Out of the same it was observed that: Value (INR Particulars Percentage millions) Cases where purchase price has 1,688.74 84% reduced/remained constant Cases where purchase price has 320.88 16% increased 2,009.62 100% Total

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 34 of 97 6. Invoice listing for FY 2012-13 7. Invoices submitted for FY2013-14 and FY2012-13 46. It was submitted that the Assessee bears the forex risk, any adverse fluctuation on foreign currency would be borne only by the Assessee. The AE has nothing to do whatsoever with the Indian leg of the transaction. Such fluctuation being due to external factors, there would be no reason for the AE to revise its rate contracts where components have been sold at consistent prices.Further the proportion of imports from AEs as against total imports is only approximately 24% and the majority of imports (76%) pertains to unrelated suppliers.It is evident from the above that the Assessee has incurred substantial cost due to fluctuation in foreign exchange rates and the Assessee has huge amount of imports when compared to the comparable companies. Therefore, the Assessee’s claim for an adjustment of INR 23.44 crores on account of adverse fluctuation in foreign exchange during the year in order to arrive at the appropriate comparability ought to be allowed.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 35 of 97 this Tribunal by it’s order dated 24.11.2021 remanded to issue to the TPO with the following observations:

“39. This issue was also considered by the Chennai Tribunal in the case of Gates Unitta India Company (P.) Ltd. (supra) and it was held as under:-

"7. We have heard both the parties and perused the material on record. In our opinion, forex fluctuations loss in the operating cost of the assessee and also forex gains in the operating income of assessee, both to be excluded from the operating expenses as well as operating income respectively in view of the Order of Tribunal in the case of Moronic India Automotive (P.) Ltd. (supra) in for assessment year 2009-10 vide order dated 17.08.2016 wherein held that:— "g. We find force in the argument of the Id. AR. It is normal that exchange rate is subject to fluctuation due to economic conditions. While determining the ALP, one has to consider these factors, more so, our view is fortified by the decision of the Tribunal in the cases of Honda Trading Corp. India Pvt. Ltd. v. ALIT in ITA No.5297/De1/2o11 for the assessment year 2007-08 and DHL Express (India) Put. Ltd. v. ALIT in ITA No.7360/Mum/2010 for the assessment year 2006-07. Accordingly, we direct the TPO to provide considerable exchange fluctuation adjustment while determining the ALP. Accordingly, this issue is remitted to the file of the TPO for determining the ALP after considering the above three components i.e. customs duty adjustment, air freight adjustment and foreign exchange fluctuation adjustment." Accordingly, this issue is remitted to the file of AO for fresh consideration." 40. Following the aforesaid decision of the Tribunal, we remit this issue to the AO/TPO with similar directions for fresh decision.” 50. Following the aforesaid order, we remand the issue to the TPO/AO for consideration afresh on the lines indicated in the decision of the Tribunal for AY 2012-13, after affording the Assessee opportunity of being heard.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 36 of 97 51. As far as Grd.No.12 raised by the Assessee is concerned, the same is in relation to the plea of the Assessee for grant of depreciation adjustment in computing operating cost of the Assessee. In this regard it was submitted that the Assessee has invested huge capital in purchasing fixed assets which are an integral part of the manufacturing operations. The Assessee incurred high depreciation cost to sales of 11.55%. As it did not manufacture the products as estimated, the Assessee could not recover its fixed costs and incurred losses.TheAssessee, without prejudice to the above arguments, has claimed adjustment to neutralize the difference between its depreciation cost and the significantly lower depreciation costs of the comparable companies. The DRP in its directions held that depreciation adjustment is related to the capacity adjustment and can be granted only in the initial years and that such high investments are observed not only for the Assessee but in the entire industry. It was further held that since the average of comparable margins are taken and a margin of 3% is also allowed, the same would take care of adjustments that cannot be carried out. 52. It was submitted that the DRP directed grant of depreciation adjustment vis-à-vis differences in depreciation cost in the Assessee’s own case in AY 2012-13, consequent to which the transfer pricing adjustment in the manufacturing segment for the AY 12-13 was reduced by INR 24.23 crores. Since there has been no change in facts from AY 12-13, the Assessee prays that the same be granted in the AY 14-15 as well. 53. Without prejudice to the arguments below on the comparability of companies chosen by the TPO, if depreciation adjustment is granted, the arithmetic mean of the margin of comparable companies adopted by the learned TPO would be -0.14%. The learned counsel for Assessee relied on the following judicial precedents:

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 37 of 97 - CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay) - SchefenackerMotherson Ltd vs. ITO reported in[2009] 123 TTJ 509 (Delhi) - CIT vs. Rakhra Technologies Private Limited reported in [2011] 15 taxmann.com 266 (Punjab & Haryana) - Amdocs Business Services (P.) Ltd. v. DCIT reported in [2012] 26 taxmann.com 120 (Pune) - ACIT v. Fiat India (P.) Ltd. [IT Appeal No.1848 (Mum) of 2009, dated 30-04-2010] - Brintons Carpets Asia (P) Ltd v. DCIT reported in [2011] 12 taxmann.com 148 (Pune)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 38 of 97

a) Rajsriya Automotive Industries. Pvt Ltd: (“Rajsriya”)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 39 of 97 (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if— (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.” 58. In terms of Rule 10B(2)( a) of the rules specific characteristics of property transferred or services provided in either transaction is a relevant criteria. It may be true that broadly the Assessee and the comparable Rajsriya can be said to be in automotive component manufacturing. However, the specific characteristics of the property manufactured by the Assessee is electrical/electronics parts whereas the comparable company Rajsriya is manufacture of automotive components. Therefore there is a difference in the specific characterics of the property manufactured. So also in terms of Rule 10B(2)( b) of the Rules, presence of intangible as an Asset employed would be a relevant criteria to choose comparable. That being the case, we are of the view that if on a narrower search, if sufficient number of comparable companies are available in the automobile electrical/electronics component, then it would be

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 40 of 97 just and proper to disregard companies who manufacture automotive components. We hold and direct accordingly.

b) TVS Upasana Ltd: (“TVS”)

Particulars TV Upasana Assessee Ltd Amt (in Rs) Amt (in Rs) Raw material cost 33,50,12,898 394,68,84,336 Sales 91,47,45,212 517,71,01,220 Raw material cost/Sales 37% 76%

It was also pleaded that TVS fails the RPT filter of 15% consistently applied by the Tribunal. Therefore, the said company cannot be considered as a comparable and ought to be excluded from the final list of comparables.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 41 of 97

c) Aspee Springs Ltd: (Aspee)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 42 of 97 that R&D activities are not relevant in selection of comparables as the same will exist is many companies. The DRP has failed to consider that Aspee has spent an amount of Rs. 40,00,000 towards development of a product which will have a material impact on the financials of the company. Aspee can be characterized as a full-fledged manufacturer while the Assessee is only a licensed manufacturer assuming normal risks and not engaged in R&D activities. The company is also in possession of intangible assets generated during the course of its operations. The proportion of raw materials consumed by the Assessee (76%) exceeds 1.5 times that of the comparable company. The relevant details as extracted from the annual reports are provided below.

Particulars Amt (Rs.) Raw material cost 14,55,03,466 Sales 30,61,07,713 Raw material cost/Sales 48%

From the above, it is evident that Aspee operates on a different business model from that of the Assessee and hence is functionally non-comparable. Therefore, the said company ought to be excluded from the final list of comparables.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 43 of 97 d) Supreme Treon Pvt. Ltd. (‘Supreme’) (formerly Supreme– Treves Private Limited)

 Interior components-trim and acoustics  Exterior components-acoustic and thermal insulation

These auto components can be categorised as mechanical or acoustic in nature. The Assessee on the other hand is engaged in the manufacture of electrical components like instrument clusters, engine systems, speed sensors, airbag controllers, anti-lock braking system etc for the automobile industry. Hence the products of Supreme cannot be compared with that of the Assessee. Since the products manufactured by Supreme are completely different from that of the Assessee, the company is functionally non-comparable and ought to be rejected.It was further submitted that the company fails the RPT filter of 25% applied by the TPO. The RPT workings as extracted from the annual report are provided below:

Particulars Amt (Rs.) Related party transactions 119,35,66,404 Sales 424,62,83,702 RPT/Sales 28.11%

It was submitted that while the DRP directed the RPT filter to be reapplied by the TPO, the same was inappropriately applied by the latter and the company

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 44 of 97 was included in the final list of comparable companies. The learned DR relied on the order of the DRP.

e) Borgwarner Morse TEC Murugappa Pvt Ltd. (‘Borgwarner’)

Particulars Amt (Rs.) Related party transactions 33,14,12,001 Sales 129,10,14,168 RPT/Sales 25.67%

It was submitted that while the DRP directed the RPT filter to be reapplied by the TPO, the same was inappropriately applied by the latter and the company was included in the final list of comparable companies. The Assesseealso submits that the raw material consumption ratio on sales of Borgwarner and the

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 45 of 97 Assessee are widely variant. The relevant details as extracted from the annual reports are provided below.

Particulars Amt (Rs.) Raw material cost 47,46,47,085 Sales 99,66,28,898 Raw material cost/Sales 48%

The proportion of raw materials consumed by the Assessee (76%) exceeds 1.5 times that of the comparable company. From the above, it is evident that Borgwarner operates on a different business model from that of the Assessee and hence is functionally non-comparable. The learned DR relied on the order of the DRP.

f) Munjal Showa Ltd: (Munjal)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 46 of 97

 IL Jin Electronics (I) (P.) Ltd v. ACIT reported in[2010] 36 SOT 227 (DELHI)  M/s Tupperware India Private Limited (ITA No. 2140/Del/2011 and 1323/Del/2012)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 47 of 97  IKA India Private Limited v. ACIT reported in [2019] 101 taxmann.com 276 (Bangalore).  CIT v. Alstom Projects India Limited reported in [2017] 88 taxmann.com 465 (Bombay)  Alstom Projects India Limited v. CIT reported in [2013] 36 taxmann.com 130 (Mumbai - Trib.)  CIT v. Thyssen Krupp Industries (P) Limited reported in [2016] 70 taxmann.com 329 (Bombay)  Claas India Pvt. Ltd., - ITA No.3883/Del/2010  CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay)  Kyungshin Industrial Motherson Limited v. DCIT reported in [2015] 57 taxmann.com 166 (Delhi - Trib.)  Emersons Process Management India (P) Ltd v. ACIT reported in [2011] 13 taxmann.com 149 (Mumbai)  DCIT Vs Starlite reported in 133 TTJ 425(Mum)  Gillete India Ltd v. ACIT reported in [2014] 44 taxmann.com 133 (Jaipur - Trib.)  Phoenix Mecano (India) Private Limited v. ITO reported in [2014] 42 taxmann.com 469 (Mumbai - Trib.)  Penfort (Israel) Limited v. Deputy Director of Income-tax reported in [2013] 36 taxmann.com 499 (Mumbai - Trib.)  ACIT v. Super Diamonds reported in [2012] 26 taxmann.com 101 (Mum.)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 48 of 97 We have already given these figures in the earlier part of this order but for the sake of ready reference, we give below the details of percentage of international transaction in the manufacturing segment, which is as follows:

Particulars As per TP order 11,73,55,1190 Transfer pricing Adjustment 6,04,57,20,000 Total operating cost 76,47,58,690 Purchase of raw materials 14,89,99,314 Payment of technical know-how 27,63,35,693 Payment of royalty 17,07,549 Payment of services availed 13,40,30,481 Payment of shared services availed 3,37,97,500 Payment for production support services availed 1,35,96,29,227 Total value of international transactions in the manufacturing segment 22.49% Percentage of international transactions to total operating cost 26,39,21,336 Revised transfer pricing adjustment restricted to percentage of international transactions 90,96,29,854 Relief from original adjustment

It was submitted that the transfer pricing adjustment (if any) should be restricted to the international transaction of the Assessee. The learned DR relied on the order of the DRP.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 49 of 97

“44. Section 92(1) of the Act provides as under:- "Any income arising from an international transaction shall be computed having regard to the arm's length price". 45. Section 92B defines the term "international transaction" to mean "a transaction between two or more associated enterprises …..” . 46. A conjoint reading of section 92 with section 92B clearly brings out that computation of income at ALP is permissible only in respect of international transaction, which, in turn, means a transaction between two or more associated enterprises. Similar position has been reiterated in the machinery provision contained in section 92C dealing with the manner of computation of ALP. Sub-section (1) of section 92C stipulates that:-

"The arm's length price in relation to an international transaction shall be determined by any of the following methods.....". 47. It is the plea of the assessee that addition by way of transfer pricing adjustment is mandated only in respect of transactions between two or more AEs. The profit from comparable transactions of the assessee with non-AEs is one of the subtle and most reliable modes for determining ALP of the international transactions. The Act does not contemplate an addition by way of TP adjustment in respect of transaction with non-AEs. 48. The TPO determined addition to total income, consequent to determination of ALP only in relation to international transaction i.e., transactions with AE in the export of finished goods segment by considering the value of international transaction at Rs.3,31,50,982 which is the value of export of finished goods by the assessee to its AE and not on the total sales in the finished goods segment of Rs.39,19,74,355 (vide para 8.3 of the TPO’s order). 49. The Hon'ble Bombay High Court in the case of Phoenix Mecano (India) Private Limited [ITA No. 1182 of 2014], had to deal with the following question of law suggested by the revenue:- 6.1 Whether on the facts and in the circumstances of the case, the Hon'ble Tribunal was correct in directing the AO to restrict the

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 50 of 97 determination of the ALP to transactions with the AE rather than on the entire turnover of the Company. 6.2 Whether on the facts and in the circumstances of the case and in law, the Hon'ble Tribunal was correct while issuing the above directions without appreciating the observations of the DRP that there was no segmental audit of the transactions of AE and non AE and therefore there was no method whereby the AO could come to a fair determination of ALP by only restricting to transactions with AE." 50. The Hon’ble Bombay High Court on the above questions of law held as follows:- “5. With the assistance of the learned counsel for respective parties, we have considered the submissions and the judgment of the Tribunal. The Tribunal in para 7 of its order has observed as under:- "7. We have heard both the parties and their contention have carefully been considered. So far it relates to grievance of the assessee that the TP adjustment can only be applied to international transactions of the assessee with the AE and it cannot be applied at entity level, the issue is found to be covered by the aforementioned decision of the Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. (supra). Therefore, we hold that determination of arms length price should be restricted only to international transaction of the assessee with its AE. It was pointed out that the figures are available with the AO, details of which has also been filed before us at page 170 of the paperbook. Therefore, we direct the AO to take only the international transactions of the assessee with its AE for the purpose of determining arms length price. We direct accordingly." 6. The Tribunal has held that the figures are available with the Assessing Officer, the details of which has also been filed with the Tribunal at page 170 of the paperbook. It would be clear that the details of the international transaction are specifically made available and therefore the apprehension of the department as such is misplaced. …….. 7. Considering the provisions of Section 92 of the Income Tax Act, so also the reasoning adopted by the Tribunal suggesting that separate figures of international transaction are available, so also

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 51 of 97 the order referred above. No substantial question of law arises for consideration. As such the appeal is dismissed with no costs." (Emphasis supplied) 51. The Hon'ble Mumbai Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 7032/Mum/2011] held that the ALP can only be determined on the value of international transaction alone and not on the entire turnover of the assessee at entity level. This decision was further upheld by the Hon'ble Bombay High Court in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 2201 of 2013], which held as below:- "2. .............. (a) Whether on facts and the circumstances of the case and law, the Tribunal was justified in law in restricting the Transfer Pricing (TP) adjustment only to the transaction between the Associated Enterprises (AEs.)? 3. ........... ……….. (e) We find that in terms of Chapter X of the Act, redetermination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transaction and not transactions entered into by assessee with independent unrelated third parties. This is particularly so as there is no issue of avoidance of tax requiring adjustment in the valuation in respect of transactions entered into with independent third parties. The adjustment as proposed by the Revenue if allowed would result in increasing the profit in respect of transactions entered to with non-AE. This adjustment is beyond the scope and ambit of Chapter X of the Act. 5. In the above view, as the provisions of the Act in respect of transfer pricing are self evidence, Question No.(a) as proposed does not give rise to any substantial question of law. Thus not entertained.” 52. The ITAT Bangalore in the case of Kirloskar Toyota Textile Machinery Pvt. Ltd. v. ACIT [IT(TP)A No.1401/Bang/2010 held as under:- “Taking into consideration of these factors, we accept the first fold of submission made by the learned counsel for the assessee and direct the Assessing Officer to confine the adjustment, qua the

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 52 of 97 purchases made by the assessee from the AE. To be more specific, the adjustment is to be made only to the purchases made from the AE ….. (emphasis supplied) 53. The CIT(A) in exercise of his powers of enhancement of income took the view that the ALP has to be determined on the basis of the entire sales in the finished goods segment including transactions with Non-AE also. The reasoning adopted by the CIT(A) for doing so was as follows:- “10.0 While examining the working of ALP in the case of appellant, it was observed that the TPO has reduced the adjustment proportionately by holding that only 8.46% of revenue of the appellant is from AE. She accordingly adopted 8.46% of the operating revenue and 8.46% of the Operating cost for purpose of the determination of ALP. However, this method is not the correct approach as the ALP determination should have been based on the entire operating revenue and entire operating cost. Since this change in method would have amounted to enhancement of the income of the appellant, so opportunity of being heard was given to the appellant vide order sheet entry dated 11.08.2017, as to why the proportionate reduction done by the TPO should not be disregarded. The appellant sought time to file written submissions and the same was allowed. The appellant filed written submissions vide letter dt 29.08.2017. The same have duly been considered and the issue is being decided as follows: 10.1 In the case under consideration, the appellant is selling its product to AE as well as to non AEs, for the manufacture of which, part purchases are from AEs and remaining from the non AEs. The TPO has considered OP/OR for purpose of computation of the ALP as the quantum of sales to AE are lesser than the purchase from AE and thus lesser controlled. When a product is sold, only overall profit margin is recorded without any data as to what would be the profit in relation to purchases from AE. So this cannot be presumed that the profit percentage earned in relation to costs related to AE transactions as well as non-AE transactions was same. Since costs are common to the products ultimately sold by the appellant, and the same includes AE transactions, so it is always possible that the margin of profit percentage vis-a-vis costs related to AE transaction is not the same as profit margin on costs related to non-AE transactions but ultimately overall certain profits are being shown. Further, the transactions with non-AEs can be presumed to be at

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 53 of 97 arm's length as there is no reason to earn lesser profit. But in case of transactions with AEs, there is always a likelihood of earning lesser profits as transactions are controlled and decisions are influenced by AE. Thus the overall profits on account of transactions with AE as well as non-AE gets suppressed.” 54. We have heard the rival submissions. The ld. counsel for the assessee reiterated submissions made before the CIT(A) that transaction with non- AE cannot be subject matter of determination of ALP because section 92 clearly speaks of determination of ALP only in respect of transactions with AE. He also referred to certain decisions of the Tribunal for the proposition that section 92 of the Act is not applicable to non-AE transactions. These decisions have already been extracted in the earlier paragraphs. The ld. DR relied on the order of the CIT(Appeals). 55. We have considered the rival submissions. The reasoning of the CIT(A) for considering the entire sales in manufactured finished goods segment for determination of ALP is that certain components and raw materials used in manufacture of finished goods are also sourced from AE and there is a possibility of the cost of such component having been bargained at a price which is not at arm’s length. This presumption of the CIT(Appeals) is without any basis. He has not demonstrated with actual figures as to how there would be impact on profit margin on sale of finished products to AE because of purchases of some components from AE. He has given examples which are imaginary figures. Apart from this, the TPO has accepted that purchase of raw material and components by the assessee from its AE is at arm’s length. Therefore, the basis on which the CIT(A) proceeded to apply the ALP test for transactions with non-AE is neither correct on facts nor permissible in law. As rightly contended by the assessee, section 92 of the Act can be applied only in respect of international transactions i.e., transactions with AE. 56. In view of the above transfer pricing provisions and various judicial precedents, we hold that the transfer pricing adjustment should be restricted only to the AE related transactions of the assessee.” 74. The facts and circumstances of the case in this appeal on this issue is identical to the case decided by the Tribunal in the case of IKA (supra). The reasoning of the CIT(A) in this case and the case of IKA (supra) are also identical. Therefore the decision rendered in the case of IKA (supra) squarely applies to the present case. Therefore, the adjustment on account of

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 54 of 97

determination of ALP has to be restricted only to that part of the transaction with AE and not the entire value of the manufacturing segment as was done by the revenue authorities. 75. As far as Grd.No.17 is concerned, the Assessee in this ground has challenged the order of the TPO whereby he treated the payment of Research and Development and licence fee (Royalty) to the AE as at nil. In this regard it was submitted that the TPO erred in making an adjustment treating the ALP as ‘Nil’ with respect to royalty fee payment on the ground that the Assessee had failed to prove that the services were actually rendered by the AE. It was submitted that though the DRP has upheld the order of the TPO, the DRP has held that as the adjustment in the manufacturing segment being made under TNMM incorporating the payment of license fee/royalty as a part of the operating cost, the adjustment comes to more than the amount of royalty and therefore, no separate adjustment is called for royalty. Further, the DRP held that in the event, the margin of the manufacturing segment is at arm’s length or the adjustment under TNMM works out to be less than the payment for license fee/royalty, then the adjustment made towards royalty would be revived. It was submitted that as no adjustment with respect to royalty has been made in view of the adjustment in the manufacturing segment being more than the amount of royalty, the said ground may not be adjudicated at this stage. However, the Assessee reserves liberty to urge this ground at a later stage in the event the adjustment made towards royalty is revived.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 55 of 97 78. SWD SERVICES SEGMENT OF THE ASSESSE

It is not in dispute that the transaction of rendering of SWD services by the Assessee to it’s AE is an international transaction.

ANALYSIS OF THE ASSESSEE’S TP STUDY AND THE TP ORDER

Net mark-up on cost earned by the Assessee (as reflected in the TP Order): Operating Income Rs. 1,38,06,40,000/- Operating Cost Rs.1,29,89,30,000/- Operating Profit (Op. Income – Op. Cost) Rs.8,17,10,000/- Operating/Net mark-up (OP/OC) 6.29% Comparison of the TP studies done by the Assessee and TPO:

Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator OP/TC OP/OC (PLI) Database used PROWESS & PROWESS &Ace- CAPITALINE PLUS TP Comparables selected 9 8 Filters applied by Assessee in its TP study:

Step Description 1. Companies reporting net sales >Rs. 1 crore – selected 2. Companies with positive net worth - selected 3. Companies reporting average manufacturing & trading income/average net sales>50% - selected 4. Companies having related party transactions> 10% of operating revenue- rejected. 5. Companies which were functionally comparable – selected Comparables selected by Assessee and their arithmetic mean: Sl. No. Name of the company Weighted Average margin (in %) 1. Akshay Software Technologies Ltd. 4.39 2. Cigniti Technologies Ltd 8.58

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 56 of 97 Sl. No. Name of the company Weighted Average margin (in %) 3. KALS Information Systems Ltd 12 4. R S software (India) Limited 16.48 5. Sasken Communication Technologies 6.24 Ltd 6. Tata Elxsi Ltd 14.49 7. Expert Global Solutions Pvt Ltd 13.36 8. Hepatica Technologies Pvt Ltd -1.43 9. Hinode Technologies Pvt Ltd -3.60 Arithmetical Mean 5.71% The TPO selected 3 comparables from the TP study of the Assessee and rejected 6 comparables selected by the Assessee in its TP study. Filters applied by the TPO: Step Description 1. Companies whose data is not available for FY 2013-14- excluded. 2. Companies which are functionally comparable - selected 3. Companies having different financial year ending (i.e. not March 31, 2014) or data of the company does not fall within 12 month period i.e., 01-04-2013 to 31-03-2014- rejected. 4. Companies whose service income <Rs. 1 Cr- excluded. 5. Companies whose software development service income is less than 75% of the total operating revenues- excluded. 6. Companies which have more than 25% related party transactions of the sales- excluded. 7. Companies which have export service income less than 75% of the sales- excluded. 8. Companies with employee cost less than 25% of turnover- excluded. Comparables selected by TPO and their arithmetic mean: Sl. Name of the Company OP/OC (in No. %) 1 Infosys Ltd. 36.13 2 Larsen & Toubro Infotech Ltd. 24.61 3 Mindtree Ltd. 20.43 4 Persistent Systems Ltd. 35.10 5 R S Software (India) Ltd. 24.25 6 Cigniti Technologies Ltd. 27.62 7 SQS India Ltd. 22.37

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 57 of 97 8 Thirdware Solution Ltd. 44.68 AVERAGE MARK-UP 29.40%

Computation of arm’s length price by the TPO and the adjustment made: Arm’s Length Mean Mark-up 29.40% Operating Cost Rs.129,89,30,000/- Arm’s Length Price @129.40% of cost Rs.168,08,20,000/- Price Received Rs.1,38,06,40,000/- Shortfall being adjustment u/s. 92CA Rs.30,01,80,000/- 79. Aggrieved by the aforesaid determination of ALP by the TPO in the draft order of Assessment by the AO, the Assessee filed objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. The DRP issued directions, whereby it upheld the contentions of the TPO, subject to the following directions:

Selection of comparable companies:

The following companies were directed by the DRP to be excluded from the list of comparables by accepting the contentions of the Assessee: (i)Cigniti Technologies Ltd.; and (ii) SQS India Ltd. The DRP also directed the inclusion of CG-Vak Software and Exports Ltd. The TPO was directed to examine the RPT of Expert Global Solutions Pvt. Ltd. and include the same if it satisfied the RPT filter, which the TPO accepted and included in the OGE. However the other contentions of the Assessee seeking the exclusion of incomparable companies and inclusion of comparable companies came to be rejected.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 58 of 97 Working capital adjustment:

The DRP upheld the action of the TPO in not granting any adjustment towards the differences in working capital (“WC Adjustment”) of the Assessee and the comparable companies.

On giving effect to the above directions issued by the DRP, the final list of comparables is as follows:

Sl. No. Name of the Company 1. Infosys Ltd. 2. Larsen & Toubro Infotech Ltd. 3. Mindtree Ltd. 4. Persistent Systems Ltd. 5. R S Software (India) Ltd. 6. Thirdware Solutions Ltd. 7. CG-Vak Software and Exports Ltd. 8. Expert Global Solutions Pvt. Ltd.

(i) That the DRP erred in upholding the inclusion of Infosys Ltd., Persistent Systems Ltd., Mindtree Ltd, Larsen and Toubro Infotech Ltd. and Thirdware Solutions Ltd. (Ground No. 23).

(ii) That the DRP erred in not directing inclusion of Akshay Software Technologies Ltd., KALS Information Systems Ltd, Sasken Communication

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 59 of 97 Technologies Ltd., Hepatica Technologies Pvt Ltd., Maveric Systems Ltd., Daffodil Software Ltd., and I2T2 India Ltd. (Ground No. 24).

(iii) That the DRP erred in not granting WC Adjustment (Ground No. 25).

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 60 of 97 6.1 It was stated that there is no change in facts. Accordingly, following the decision rendered in the assessee’s own case in AY 2008-09, we direct exclusion of M/s Infosys Ltd. 7. In AY 2008-09, the co-ordinate bench has excluded M/s Persistent Systems Ltd also by following the decision rendered in the case of 3DPLM Software Solutions Ltd (supra), where in it was held that M/s Persistent Systems Ltd is engaged in product development and product design services while the assessee is a software development service provider. Further, the segmental details were not available. 7.1 It was stated that there is no change in facts. Accordingly, following the decision rendered in the assessee’s own case in AY 2008-09, we direct exclusion of M/s Persistent Systems Ltd. 8. We also notice that in AY 2008-09, the co-ordinate bench has excluded M/s Thirdware Solutions Ltd also by following the decision rendered in the case of 3DPLM Software Solutions Ltd (supra), where in it was held that M/s Thirdware solutions Ltd is engaged in product development and earns revenue from sale of licenses and subscription. Further, the segmental details were not available. 8.1 It was stated that there is no change in facts. Accordingly, following the decision rendered in the assessee’s own case in AY 2008-09, we direct exclusion of M/s Thirdware Solutions Ltd. 84. As far as exclusion of Larsen & Toubro Infotech Ltd., is concerned, the Tribunal in the very same case of M/s. LG Soft Pvt. Ltd. (supra) in another order dated 27.9.2019 in MP No.95/Bang/2019 held that exclusion of Larsen & Toubro Infotech Ltd., was omitted to be adjudicated in the original order dated 28.5.2019 passed by the Tribunal referred in the earlier paragraph and held that Larsen & Toubro Infotech Ltd., is also not a comparable company because there were extraordinary events that occurred in the relevant previous year and that it possessed brand and intangibles and there was no segmental information of sub- contracting expenses.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 61 of 97 85. Respectfully following the aforesaid decision, we direct exclusion of (1) Infosys Ltd. (2) Larsen & Toubro Infotech Ltd. (3) Persistent Systems Ltd. & (4) Thirdware Solutions Ltd. from the list of comparable companies.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 62 of 97 87. Having considered the rival submissions, we find that this company was sought to be excluded from the list of comparable companies before the DRP on the ground of functionally dissimilar- diversified operations, revenue from Subcontracting charges, Onsite revenue, Segmental data unavailable, presence of R&D activity, Presence of intangibles, existence of IP led solutions and large Scale operations. This plea was refused by the DRP on the following findings viz., that this company was not engaged in product sales as contended. In note 2.8.1 of the financial statement shows revenue is derived primarily from software services and there is no reference to revenue from product sales. Asset schedule refers to IPR value of Rs. 67 million, which is meager. No specific debit towards R&D in the P/L account. Assessee failed to establish material effect on margin on account of intangibles/patents. Assessee failed to justify the significant expenditure in foreign currency affects comparability and in any event Assessee cannot be aggrieved by a company which undertakes onsite development activity in which the profit earned is low.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 63 of 97 with major operations offshore, due to the reason that the economics and profitability of onsite operations are different from that of offshore business model. As already stated the Assessee has limited its analysis only to functions but not to the assets, risks as well as prevailing market conditions in which both the buyer and seller of services located. Hence, the companies in which more than 75% of their export revenues come from onsite operations are to be excluded from the comparability study as they are not functioning in similar economic circumstances to that of the tax payer. Hence, it is held that this filter is appropriately applied by the TPO. We are of the view that it would be just and appropriate to remand the issue of comparability of Mindtree Ltd.,to the TPO/AO afresh in the light of the principles set out above and apply the onsite revenue filter. We hold and direct accordingly.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 64 of 97 18.12.2019 for AY 2014-15, wherein in the comparability of this company was remanded to the TPO for consideration afresh. The ld. DR relied on the order of the DRP.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 65 of 97 TPO has rejected without any basis and was excluded on the ground that the company was engaged in R & D activity and expenditure is 6% of total turnover. Similarly, the DRP has upheld the exclusion of the company. The learned Authorised Representative submitted that company’s functional profile is comparable and applied the TPO filters. Whereas the DRP has observed that the company has incurred substantial expenses to the tune of 6% of turnover towards R & D and the tolerable limit is 3%. We found the observations of the DRP are without any basis. Accordingly we restore this issue to the file of TPO to give a logical conclusion and findings.” 94. Following the aforesaid decision, we remand the issue of inclusion of this company i.e., Maveric Systems Ltd. to the TPO for fresh consideration on the lines directed in the order of the Tribunal referred to above.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 66 of 97 Thereafter, the company has been only engaged in provision of the software development activities and had not owned any software products during the year ended March 2014. Therefore, it was submitted that the company ought to be included in the final list of comparables. We are of the view that this aspect was not examined either by the TPO or DRP and therefore deem it fit and appropriate to remit the issue and direct the TPO/AO to consider the claim in this regard.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 67 of 97 export revenue filter applied by the TPO. It was submitted that Sasken has incurred research and development expenditure only to the tune of 0.50 percent of the software services revenue amounting to INR 35,083.49 lakhs. Therefore, it was submitted that the company ought to be included in the final list of comparables. We have considered the submissions and are of the view that it would be appropriate to remit the issue and direct the TPO/AO to consider the claim in this regard afresh as the DRP has drawn conclusions, without opportunity to the Assessee.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 68 of 97 to be a product company also and no segmental details are available and if that finding is not in challenge, then that ground would be sufficient to disregard this company as a comparable company and therefore the presence of intangibles would not make any difference. Hence, the plea of the Assessee for inclusion of this company as a comparable company is rejected.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 69 of 97 the SWD services segment, after due opportunity of being heard to the Assessee afforded.

CORPORATE TAX GROUNDS

a. General Provision for warranty – The Assessee creates general provision for warranty on a scientific basis towards the expected liability that could arise during such warranty period. The Assessee creates provision for warranty on the percentage of sale for each product. The quality department based on past experience and historical trend of the performance of each product arrives at a percentage based on which provision for warranty is created.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 70 of 97 b. Additional provision for warranty – Bearing in mind the nature of industry of that of automobile components manufacturer, the Assessee needs to create additional provision for warranty based on the circumstances and specific cases. During the year under consideration, there was no additional provision for warranty created.

The movement in provision for warranty as accounted for by the Assessee for the year under consideration is as under:

Amount in INR Particulars General Specific Total Warranty Warranty Opening balance 2,60,13,380 2,81,32,797 5,41,46,177 Add: Provision created 3,21,32,433 0 3,21,32,433 during the year (debited to P & L A/c) Less : Actual warranty (2,60,13,380) (2,27,52,798) (4,87,66,178) claims Closing balance 3,21,32,433 53,79,999 3,75,12,432 Amount directly 2,61,30,796 0 2,61,30,796 debited to profit and loss account It was pointed out that it can be seen from the movement of provision for warranty tabulated above, the actual utilization (Rs. 4,87,66,178) during the year under consideration is more than the provision created (Rs. 3,21,32,433).As such the net impact that has been considered in the profit and loss results in negative amount (Rs. -1,66,33,745). To this amount, certain warranty expense which is not in the nature of provision and directly incurred by the Assessee (Rs. 2,61,30,796) has been added. Therefore, the net warranty expense of Rs. 94,97,051 is reflected in the profit and loss account.Accordingly, the learned counsel for Assessee submitted that the utilization of the expense is

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 71 of 97 on the higher side compared to the provision created, which itself indicates that the methodology followed by the Assessee is scientific. It was pointed out that in the draft assessment order, the AO had made several observations which the Assessee had clarified before the DRP as under: Learned AO’s Assessee’s submission Reference Sl. contention No. There is a huge The difference between the 1 difference provision amount and the between utilization amount is not the provision benchmark that is required to amount and be considered. What needs to utilization be seen is whether the provision created is on scientific basis. The amount of provision is a factual outcome of the methodology followed in creating provision and utilization would be the actual expenditure incurred against the warranty claims. In the present case, the Assessee has followed the scientific methodology based on which provision amount is arrived at. Further, utilization amount represents expense incurred on actual claims received by the Assessee. Provision is The Assessee had submitted Please refer 2 made on following details to the AO: paper book - estimate basis/ Volume-3 filed adhoc basis on 11 March  Ledger extract for actual 2019 warranty expenses incurred by the Assessee along with Page No.1385 the supporting documents to 1509 on sample basis Summary of provision Page No.1511  created for warranty

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 72 of 97 The above evidences the methodology of creating such provision and substantiates that the warranty policy adopted by the Assessee is on scientific basis and not adhoc basis. Actual warranty 3 The AO failed to appreciate claims debited that the Assessee adjusts actual to profit and loss warranty claims against account/ No provision in the provision separate ledger account, a separate ledger is maintained for the said purpose.

Further, certain direct actual warranty expense not in the nature of provision was directly debited to profit and loss account. It was reiterated that the Assessee follows the specific methodology of creating provision for warranty consistently over the years. The said methodology has been submitted before the AO during the course of assessment proceedings. It was submitted that the Assessee creates provision for warranty on a scientific basis.

 Rotork Controls India Private Limited [2009] 180 Taxman 422 (SC)  Nokia Siemens Networks India Private Limited Vs. CIT[2011] 14 Taxmann.com 84 (Karnataka High Court);  Micro Land Ltd [2012] 18 taxmann.com 80 (Karnataka High Court);  Toyota Kirloskar Motors (P.) Ltd. v CIT [2013] 30 taxmann.com 294 (Karnataka High Court);

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 73 of 97  Hewlett Packard India Sales (P.) Ltd. v CIT [2014] 49 taxmann.com 166 (Karnataka High Court);  Motor Industries Co. Ltd. v CIT [2015] 55 taxmann.com 377 (Karnataka High Court);  Denso Kirloskar [2013] 34 taxmann.com 238 (Karnataka High Court);  Ericsson Communications Pvt. Ltd v CIT [2009] 318 ITR 340 (Delhi High Court). Further, in Assessee’s own case for AY 2009-10 and AY 2010-11, the DRP directed the AO to delete the disallowance in respect of provision for warranty.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 74 of 97 warranty stands vindicated by the fact that the actual liability on account of warranty expenses is always on the higher side. The reasons given by the DRP for not accepting the claim of the Assessee is that the provision is created as a percentage of sale, ignoring the fact that past experience is also the basis for creation of provision for warranty. We are therefore of the view that the provision for warranty has to be allowed as a deduction, as the provision created satisfies the requirements for claiming provision as a liability, as laid down in the judicial precedents referred to above. We hold and order accordingly and allow the relevant ground of appeal of the Assessee.

Sl. No. Nature of expenses Amount in INR 1 License fees to group companies 21,36,97,972 2 Project Research and Development expenses 6,59,74,419 3 Third party and others 3,48,724 Total 28,00,21,116 The Assessee submitted that it had entered into two license agreements with Continental Automotive GmBH, Germany and Continental Teves AG & Co., Germany dated 1.1.2009 and 11.3.2019 respectively, whereby it was given non- exclusive, non-transferable licence to use intellectual property for manufacturing and sale of automotive products; and payment of compensation as an annual royalty on net sales for use of intellectual property. The Assessee claimed the above expense as one incurred for the purpose of business and revenue in nature and therefore claimed as deduction by the Assessee under section 37 of the Act.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 75 of 97 109. The AO disallowed the above for the reason that the reasons for mention “licence fee” as R & D expenses were not submitted and except the Agreement, no supporting documents were furnished with regard to technical know-how provided by the group companies. He also held that the expenditure would give an enduring benefit and would therefore be a capital expenditure. The AO also held that there was no rationale for payment of licence fees when there was import of raw material, consumables and other supplies from the AEs.

SUBMISSIONS ON LICENSE FEES PAID TO GROUP COMPANIES OF Rs.21,36,97,972:

Agreement A (page refer page no. 1527 to page no. 1539 of the paper book – volume 3 filed on 11 March 2019): The Assessee has entered into a License Agreement dated 1 January 2009 with Continental Automotive GmbH, Germany ("CA GmbH").

 Under this agreement, CA GmbH grants a non-exclusive, non-transferable license to use intellectual property owned by it as well as the technical information, to the Assessee for development, manufacturing and sale of automotive products.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 76 of 97  Compensation for the aforementioned license has been agreed to be paid by the Assessee as an annual royalty of 3% of net sales on account of use of intellectual property generated from basic R&D and 2% on net sales (which shall decrease by 0.25% during every calendar year after 2009) on account of use of intellectual property generated from old application R&D. [Basic R&D is Product related research and development for the general benefit of the company in manufacturing of the automotive products and Application R&D is Customer specific product related research and development].

Agreement B (page refer page no. 1541 to page no. 1551 of the paper book – volume 3 filed on 11 March 2019): The Assessee has entered into a License and Technical Assistance Agreement dated 1 January 2009 with Continental Teves AG & Co. OHG, Germany ("CT AG").Under this agreement, CT AG grants license to use technical information for development, manufacture and sale of sensors and supply information relating to commercial manufacture, sale and distribution.Compensation for the aforementioned license has been agreed to be paid by the Assessee as an annual royalty fees of 6% of net sales of sensoric products per year.

i. Section 37 of the Act is a residual clause for claiming deduction for any expenditure incurred for the purposes of the business.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 77 of 97 ii. For the purpose of claiming deduction under section 37 of the Act, the following conditions should be fulfilled:  The expenditure must be revenue in nature and should not be covered by any express deductions under sections 30 to 36 of the Act.  The expenditure should not be personal in nature.  The expenditure should be incurred wholly and exclusively for the purposes of the business or profession. iii. The annual license fee is payable for making use of licensed intellectual property and/ or technical information owned by the Continental Group. iv. Such payments are made only towards “access” to technical knowledge and not absolute transfer of technical knowledge or information. v. Such expenses were incurred by the Assessee for increasing profitability relating to products manufactured by the Assessee by applying new methods of manufacture/ technology provided under the aforementioned agreements. vi. The object of the aforementioned agreements was to obtain the benefit of technical knowledge available with the licensors, for running the business of the Assessee. vii. Further, the license fee is calculated as a percentage of sales, hence, it is recurring in nature and there is no enduring benefit derived by the Assessee in this regard. Accordingly the same should be considered as revenue in nature and should be allowed as deduction under section 37(1) of the Act, since it satisfies all the aforementioned conditions.

 Kanpur Cigarettes (P.) Ltd. v. CIT 147 Taxman 428 (Allahabad High Court)  CIT v. Kirloskar Tractors Ltd [1998] 231 ITR 849 (Bombay HC)  Alembic Chemical Works Co. Ltd. v. CIT [1989] 43 Taxman 312 (SC)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 78 of 97  J.K. Synthetics Ltd. v. CIT[2009] 176 Taxman 355 (Delhi High Court)  DCIT v. Honda SIEL Power Products Ltd I.T.A .No. 1579/DEL/2017 (A.Y 2012-13) & S. A No. 217/Del/2017 in ITA No. 1579/Del/2017

Factors under Whether the conditions Clause reference in the consideration are satisfied? Agreements A and B License period Yes. Both the licenses are  Agreement A - 6.1.2 and termination granted for a limited period.  Agreement B - 7.1 The agreements can be terminated at the discretion and 7.2 of both parties.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 79 of 97 Factors under Whether the conditions Clause reference in the consideration are satisfied? Agreements A and B Restriction on Yes. The Assessee can sub-  Agreement A - 2.2 creation of license only on receipt of  Agreement B - 3.1 further rights/ prior written approval from assignment the Licensor.

Confidentiality Yes. The Assessee is  Agreement A - 8 obligated to hold in  Agreement B - 6.1 to confidence all the information provided under 6.5 the agreement.

Degree of Yes. The scope of the license  Agreement A - 2.1 transfer is only to grant right to use  Agreement B - 3.1 licensed intellectual property. There is no transfer of absolute ownership of any intellectual property. Nature of Yes. Royalty was paid based  Agreement A - 5.1 royalty on a percentage of net sales  Agreement B - 4.1 as provided in the agreements

- Standard Practices:

a) Continental global provides access to standard procedures, methodologies, best practices, knowledge updates, etc. relating to

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 80 of 97 manufacturing process of a product. These are provided largely through software platforms used by Continentalgroup on a standardized basis across the world. These are continuously updated and the latest versions of the same are made available through portals/tools.

b) The global team works on the upgradation of current technologies and products. It also avoids parallel work of a similar kind among the group entities. The sharing of best practices on technical know-how, manufacturing processes and techniques is the foundation for Continental group’s business as an organization as they aim to serve the customer’s requirements in a standardized manner. The Assessee being part of the group benefits out of such knowledge sharing and technical guidance and support.

c) Some of the key benefits out of the above support to the Assessee includes timely business planning, optimum resource utilization, and meeting customer’s requirements where the expectation is always to deliver as per global standards, gaining competitive advantage, and running the business smoothly and efficiently.

d) Corporate Project Management Manuals and Standards – CPMMs and CPMS provided by Continental global aid in project management. Further, the Assesseerefers to the standard document provided by Continental global in planning introduction of a new product, which provides basic guideline for innovation introduction. Continental group provides the latest updates relating to development of key manufacturing technologies. This helps the Assessee to upgrade its business including the manufacturing process to the latest available technology.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 81 of 97 before this Hon’ble Tribunal under cover of an application for additional evidence. The additional evidence sought to be filed by the Assessee are the following.

Sl. Particulars Page No. Nos. 1 Annexure 1 - License agreement 521-534 2 Annexure 2 - License and technical assistant agreement 535-546 3 Annexure 3 - Sample invoice copies 547-560 4 Annexure 4 - Ledger abstract of Research and Development 561-562 expenses 5 Annexure 5 - Project management process 563-574 6 Annexure 6 - Future technologies 575-576 7 Annexure 7— Technology roadmap 577-588 8 Annexure 8 — Key manufacturing technologies 589-590 9 Annexure 9 - Strategic areas for the business development 591-592 10 593-606 Annexure 10 — Tech.net 11 Annexure 11 - Tech.net snapshot 607-608 12 Annexure 12 — Cabot concept 609-616 13 617-620 Annexure 13 - Camline report 14 Annexure 14 - Equipment status Report 621-624 15 Annexure 15 - Camline planning tools 625-626 16 Annexure 16 - Manufacturing execution systems ("MES") 627-628 17 Annexure 17 - Compliance information communication 629-630 18 Annexure 18 - Global material shortage communication 631-632 19 Annexure 19 - Risk mitigation measures communication 633-636 20 Annexure 20 - Design for Six Sigma for development of new 637-648 product 21 Annexure 21 — Planning a factory sequence of phases 649-670 22 Annexure 22 - Team structure of CEP manufacturing 671-672

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 82 of 97

23 Annexure 23 - Training on application of new methodology 673-674 24 Annexure 24 - Library sharing 675-676 25 Annexure 25 — Screenshot of a project 677-678 26 Annexure 26 - Verification procedures 679-690 27 Annexure 27 - Webinars for testing 691-692 28 Annexure 28 - Software source code 693-694 29 Annexure 29 - Technical support email communication 695-696 30 Annexure 30 - Manufacturing technology support from experts 697-700 31 Annexure 31 - Faulty part detection communication 701-704 32 Annexure 32 - Support from Germany 705-706 33 Annexure 33 - Quality ranking 707-708 34 Annexure 34 - Taskforce 709-712 35 Annexure 35 - Robots service agreements 713-714 36 Annexure 36 — Key milestones 715-716 37 Annexure 37 - Intellectual property of Continental global 717-744

The additional evidence is necessary for proper adjudication of the dispute viz., to understand the nature of expenditure in question.

- Access to various tools/platforms

a) There are numerous tools/ software platforms that are made available by Continental global to the Assessee for the purpose of its business. These tools are developed in-house by Continental global or developed by third party and customized for use by Continental group. These tools/software

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 83 of 97 platforms are primarily online tools/platforms and shared drives which facilitate various technical support including:

- Sharing of best practices/ standard procedures (discussed above).

- Real-time production control and monitoring.

- Planning/ forecasting the material and labor requirements.

- Survey the customer’s demands/ requirements.

- Tracking and overall management of the project on real-time basis.

- Integration of costing software and accounting software (SAP).

b) Various tools like tech.net, prod.net, log.net, camlineetc are provided to the Assessee and some of the key tools in use by the Assessee are discussed below:

Sl. Tool Name Tool/ platform Benefit to description No. ‘Continental India’ 1 Tech.Net It is a platform Assessee uses Tech.net which provides (manufacturing access to latest technology network) to technical gain access to the information, technical information, standard practices, standard practices and procedures, etc. documents, and applies/ implements the same for its manufacturing Tech.Net members process, testing process, possess highest etc. level of education As mentioned earlier, (PHd) and provide this information and support centrally to support is a catalyst for each location the Assessee’s whenever a business.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 84 of 97 problem cannot be resolved locally. 2 Collaborative Cobot is an Cobot helps the robots advanced version Assessee in reducing (“Cobot”) of robots which dependency on man focuses on safety power, suppliers of raw and cost reduction. material. This enhances This is easy and overall performance simple to program with possible savings in as per the user terms of lead time and requirement. increase in efficiencies. 3 Camline Camline is an Camline analyses internal customized performance of the software for machineries over a monitoring and period and provides tracking of the line quality rates, performance of the performance rates. It machinery/ also records the equipment in the equipment status and plant during the provides report of the process of unplanned errors manufacturing. occurred. 4 Space LFPT tool is This helps the Assessee planning tool another tailor-made in planning as well as tool from optimum utilization of Continental global available resources. for management of manufacturing floor space, logistics floor space etc. 5 Manufacturing MES is an auxiliary MES is integrated with execution bundle of software the SAP system in a systems that work hand-in- way that MES provides (“MES”) hand with Camline automatic data to SAP. software/ It counts automatically platformand how many units were provides real time built, how many tests production failed, how many units monitoring. were shipped, what product routing (recipe)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 85 of 97 was used. These provide basic information for cost absorption calculation.

It’s a smart software that makes machines closer to Industry 4.0 smart equipment (industry standard).

- Assistance in sourcing:

a) Continental global has a global strategic sourcing approachi.e., strategy for obtaining raw material/ resources across the world in a standardized manner, which can achieve economic advantages in terms of obtaining significant discounts.

Continental global locates suppliers, seeks samples from them and tests their products. Upon satisfaction about the quality of the product, Continental global provides such information of suppliers located across the globe, to the group. It also negotiates for bulk discounts and set quality standards for the suppliers. This in turn helps the Assessee in procuring quality raw materials at best price without any efforts. Sample email communications demonstrating procurement of raw materials by Continental Global, instructions/solutions on raw material shortage and quality issues are produced before thisHon’ble Tribunal under cover of an application for additional evidence.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 86 of 97 - Provision of designs, procedures and layouts

Every product that the Assessee manufactures is unique and complex. Continental global develops and shares its designs, layouts and drawings relating to products, manufacturing process, etc. with the Assessee. The requirement of the customers varies from country to country and therefore, Continental global provides customized versions of its designs, layouts and drawings to the Assessee which are best suited for the Indian market.

- Training

a) Continental global conducts online courses, training through video conferencing, live training workshops etc. to equip its people with updated technologies, products and solutions, and specifically focus on measures and guidelines for implementation of standards, new technology etc. These trainings are facilitated from the global experts of the Continental group. This contributes to enhanced productivity.

- Validation

a) Continental global validates the complete product layout/ design as submitted to it by local teams for its feasibility and then provides a "go- ahead" to the local team for its implementation. This is prepared and submitted in the form of a project matrix.

b) Continental global, due to their expertise could uncover any issues at an initial stage itself. Therefore, the above process aids Continental India to prevent any issues, avoid duplication of efforts and ensures timely response to the issues beforehand.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 87 of 97 - Testing

a) A crucial aspect of any manufacturing process is testing. The Assessee undertakes testing of the products/ components as per the guidance and set standards by Continental global. Continental global releases guides/ standard practices to be followed by the Assessee for testing purposes on continuous basis.

b) Where the existing testing procedures have not been helpful or the local team is unable to render the testing equipment/ software for testing purposes, the Assessee requests the assistance of Continental global. A screenshot of the source code shared with the Assessee in one such instance is produced under cover of the application for additional evidence.

c) Sometimes, the technical support would be provided through emails. These are facilitated by the experts and generally entails steps and action points for the Assessee. Sample email communications are also part of the application for additional evidence.

- Problem resolution

a) The Assessee seeks the help of Continental global to resolve issues in cases where the Assessee is unable to do so. Continental global provides the Assessee with necessary technical support on call and through emails.

b) Continental global also voluntarily takes initiatives to mitigate the issues at every plant location across the world. If the issues are highly vulnerable and needs personal monitoring by the experts, the global team send experts to that particular location to address the specific and routine issues and bring down the occurrence of quality incidents.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 88 of 97 - Other assistance:

a) Continental globalenters into centralized agreements for procuring certain techniques, technical services. This helps the Assessee to improve the product quality. The aforesaid assistance received from Continental group helps in improving the technological performance of the Assessee’s operations in terms of quality and cost and also helps in optimum utilization of resources in an efficient manner. It also creates synergy among the group entities including the Assessee and ensures access to latest technical information.

SUBMISSIONS WITH REGARD TO PROJECT RESEARCH AND DEVELOPMENT EXPENSES OF RS.6,59,74,419:

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 89 of 97 performed for any manufacturing company, Continental Automotive GmbH will either use its own facilities, or use its group affiliates to perform the developmental work. All technical knowhow costs are charged as far as feasible, project by project to the companies which plan to manufacture the project- relevant product for the outside customer. All Application Projects actually running, are permanently listed in the SAP sub-system “Global PS” or similar tools. These lists contain the actual technical knowhow costs per project, and an indication in which manufacturing site the relevant product is planned to be produced. The manufacturing company to which the relevant plan belongs to, will be charged with the technical knowhow fee of the specific project. Therefore, the major individually chargeable projects are directly charged to the relevant manufacturing company. The relevant projects wherein the manufacturing of products are undertaken by the Assessee, are charged to the Assessee and the same are either:

 capitalised and amortised over the useful life of such Project if the Assessee has actually commercialized the same; or  charged off to the profit and loss account if the same could not be commercialized or recovered from the customers.

Amount in Rs. Particulars 4,10,56,133 Expense capitalized since the same was commercialized 4,07,27,558 Expense charged to the customers in the subsequent year (recorded as unbilled revenue in the captioned AY)

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 90 of 97 6,59,74,419 Expense charged off in the profit and loss account as it could neither be commercialized nor chargeable to the customers 14,89,99,314 Total It was pointed out that party-wise Invoice details of technical knowhow availed from group companies amounting to Rs. 14,89,99,314 and sample invoice copies thereof were submitted before the Hon’ble DRP.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 91 of 97 Learned AO’s Assessee’s submission Reference Sl. contention No. No proper The Assessee had 1 Please refer below evidences submitted the following page(s) in the furnished details to the learned AO: paper book - Volume-3: 1. Ledger extracts of Page No. 1512 R&D expense 2. Sample invoices Page No. 1513 to copies raised on 1526 Assessee by group Page No. 1527 to entities 1551 3. Copy of agreements Page No. 1553 to entered into with 1554 group entities 4. List of projects for Page No. 1555 to which amount was 1595 charged specifically to projects 5. Sample copy of two patents which in the name of Continental, Germany The above substantiates rendition of service, the nature of expense incurred and the benefits obtained by the Assessee. Reasons for Assessee had submitted Please refer page 2 classification of that R&D is only a no. 1375 of the expense as R&D nomenclature used by the paper book - not provided Assessee in the financial Volume-3 filed on statements and a major 11 March 2019 portion of the said expense is towards annual license fees paid by the Assessee to its group companies. Expense is capital From the above factual The judicial 3 in nature since it and legal basis, the precedents provides enduring Assessee submits that the discussed above benefits impugned expense is not supports the case

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 92 of 97 a capital expenditure, as of the Assessee there is no enduring that expense is not benefit derived by the capital in nature. Assessee. The same is related to the business of the Assessee. No rationale for Reliance in this 4 The Assessee submits entering into regard is placed that merely because an agreement with its on below judicial agreement is entered into, group entities since decisions, where it no businessman would the Assessee was has been observed change the business. It is carrying on the that “AO cannot for the purpose of the business even prior take managerial business that a to entering decision and businessman enters into aforesaid conclude what an agreement. expense needs to agreements be incurred by the Assessee had taken a business and what business decision to avail not”. the services from group  DCIT vs. entities to facilitate and International further its business Institute of objects. Planning It is also submitted that &Management having provided the (P.) Ltd. factual and legal basis of [2015] 41 the expense, the learned ITR(T) 733 AO cannot question (Delhi - Trib.) commercial expediency of a transaction.  CIT vs. Further, entering into Dalmia agreements for use of Cement (P.) intellectual property of Ltd. [2002] the group companies has 254 ITR 377 benefited the Assessee. (Delhi) – this was affirmed by the Hon’ble Supreme Court [2007] 288 ITR 1 (SC) Sundry creditors This is a mere remark - 5 are increasing made by the learned AO

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 93 of 97 without any basis/ conclusion towards the same. However, the Assessee submits that sundry creditors account is a running account and represents payables to third parties/ group entities for goods/ services availed from them. Evidence for The Assessee had Please refer page 6 deducting the taxes submitted details of tax no. 1303 to page at source not deducted at source before no. 1313 of the furnished the learned AO pursuant paper book - on directions issued by Volume-3 filed on the Hon’ble DRP. 11 March 2019 No rationale for Please refer point 7 The import of raw paying royalty no. 4 above material, consumable and since there are other supplies from the import of raw group companies and materials, payment of royalty are consumables, and two distinct transactions, other supplies. and the Assessee has substantiated the business rationale for the payment of royalty through evidences and submissions. Further, payment of royalty is towards use of technology of the Continental Group and technical information that helps facilitate the manufacturing activity of the Assessee.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 94 of 97 125. In view of the above submissions, the learned counsel for the Assessee prayed that the impugned expense is revenue in nature and the same is allowable under section 37 of the Act.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 95 of 97 arriving at the TP adjustment and hence, disallowance under section 37 of the Act has led to double disallowance.Further, the DRP in Assessee’s own case for AY 2012-13, had directed the AO to remove the disallowance of R&D expense made under section 37 of the Income-tax Act, 1961.In view of the above, the learned counsel for the Assessee prayed that the claim of deduction for R&D expenses be allowed.

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 96 of 97 observations made above and in the light of the evidence and additional evidence and submissions made as above, after affording the Assessee opportunity of being heard.

Pronounced in the open court on the date mentioned on the caption page.

Sd/- Sd/- (B. R. BASKARAN) (N. V. VASUDEVAN) Accountant Member Vice President Bangalore. Dated: 29.03.2022. /NS/*

ITA No.129/Bang/2019 Continental Automotive Components India Pvt.Ltd. Page 97 of 97 Copy to: 1. Assessees 2. Respondent 3. CIT 4. CIT(A) 5. DR 6. Guard file By order Assistant Registrar, ITAT, Bangalore.