TOYOTA BOSHOKU AUTOMOTIVE INDIA PRIVATE LIMITED,BIDADI vs. ASSESSMENT UNIT, INCOME TAX DEPARTMENT OR THE DCIT, CIRCLE - 7(1)(1), KORAMANGALA

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7.1 The TPO observed that a Licensed Manufacturer bears market risks and actively exploits technology to capture the market, whereas a Contract Manufacturer merely produces goods based on orders received from its principal and does not have independent control over sales or market exploitation. Since, the assessee does not make independent sales decisions, negotiate pricing, or assume inventory risks, it does not qualify as a Licensed Manufacturer. Instead, the assessee operates as a Contract Manufacturer, producing exclusively for TKML based on pre- determined orders and specifications. The TPO emphasized that Royalty is justified only when an entity benefits from exploiting the technology to capture the market, which is not the case for the assessee. While the assessee uses Toyota’s (TBC) proprietary technology, it does not actively .

IT(TP)A No.1539/Bang/2024 Page 4 of 37 market or sell its products independently, nor does it bear market- related risks. Therefore, the TPO concluded that any Royalty obligation should fall on TKML, which directly benefits from Toyota’s technology, and not on TBI being the assessee.

7.2 Additionally, the TPO identified a pattern within the Toyota Group where the liability of Royalty payments was being shifted from TKML to other Indian group entities, including the assessee. This cost reallocation allowed by Toyota to avoid benchmarking Royalty at NIL for TKML, which would have been the correct treatment under Transfer Pricing regulations. By allocating Royalty costs to the assessee and other subsidiaries, the Group effectively transferred an excessive cost burden to Indian entities, at the same time reducing TKML’s taxable income in India. This cost-sharing arrangement distorted the true economic substance of the transactions and misrepresented the actual value creation within the Toyota supply chain.

7.3 To further validate its findings, the TPO conducted a benchmarking analysis comparing Royalty payments of similar multinational corporations (MNCs). The analysis revealed that other MNCs in comparable circumstances do not pay Royalty on intra-group sales. Given that TBI functions as a Contract Manufacturer without independent market-facing responsibilities, its Royalty payments were deemed unjustifiable. Consequently, the TPO benchmarked the Royalty payment of Rs. 45,83,94,469/- to NIL, resulting in a Transfer Pricing (TP) adjustment of the same amount. The TPO also noted that TBI failed to provide a detailed breakup of Royalty payments related to transactions with both related and unrelated parties. Due to this non- .

IT(TP)A No.1539/Bang/2024 Page 5 of 37 disclosure, the entire Royalty payment was assumed to be linked to intra-group transactions and was disallowed in full.

7.4 Based on above observation, the TPO concluded that Royalty payments must align with the actual economic substance of the transaction and the extent to which an entity independently exploits market opportunities. In this case, the assessee functions solely as a Contract Manufacturer following TKML’s directives. This led to unnecessary Royalty expenses, distorting assessee’s taxable income and resulting in a significant TP adjustment. As a result, the Royalty paid by assessee to Toyota Group AEs was deemed an unjustified expense and fully disallowed in the Transfer Pricing assessment. The entire Royalty amount of Rs. 45.83 crore was benchmarked to NIL, leading to a TP adjustment of the same amount.

8. Being aggrieved the assessee preferred to file objection before the learned DRP.

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12.1 The learned AR further contended that the TPO incorrectly claims that the assessee does not face market risk because it produces goods for TKMP, a related party. However, the assessee is responsible for selling its products to TKMP, and market risks arise if the demand for TKMP’s cars declines, thereby affecting the assessee. Therefore, the claim that the assessee faces no market risk is incorrect. Furthermore, the assessee’s production is based on projected demand from TKMP, which is a standard business practice and does not support the TPO’s contention that the assessee is a contract manufacturer.

12.2 The learned AR argued that the TPO’s analysis of functions, assets, and risks (FAR) is flawed and has been manipulated to conclude that the assessee carries no risks merely because most of its sales are to .

IT(TP)A No.1539/Bang/2024 Page 7 of 37 a related party. The TPO incorrectly assumes that any sales to a related party automatically classifies the entity as a contract manufacturer. This issue has already been adjudicated in the case of SC Enviro Agro India Pvt. Ltd. (ITA No. 6060/Mum/2011), where the Tribunal dismissed a similar contention by the TPO, holding that revenue authorities cannot dictate business decisions and that expenses incurred for business purposes cannot be disallowed on arbitrary grounds.

12.3 The learned AR submitted that the TPO has also wrongly disallowed royalty payments by assuming that a contract manufacturer should not pay royalties. However, the assessee has entered into an approved agreement for paying royalties at 5% for a period of seven years, and no disallowance was made in previous years. The payment of royalties is for the utilization of technical know-how and licenses essential for manufacturing and is wholly and exclusively for business purposes. A similar issue was examined by the Hon’ble Delhi High Court in the case of Samsung Communication (ITA No. 40/2018), where the court ruled that the presence of technical know-how provided by a group company and predominant sales to an associated enterprise (AE) does not automatically imply that a company is a contract manufacturer. The court rejected the TPO’s contention in that case, and the same principle should also be applied here.

12.4 In conclusion, the learned AR submitted that the TPO's characterization of the assessee as a contract manufacturer is incorrect, and the disallowance of royalty payments is unjustified and accordingly pleaded to dismiss the TPO’s findings and uphold the assessee's position in the light of the judicial precedents cited.

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14.1 However, the TPO separately benchmarked the royalty payment using the Profit Split Method (PSM) as the most appropriate method and made the necessary adjustment. The dispute reached this Tribunal in the assessee's appeal in IT(TP)A No. 1646/Bang/2017. The Tribunal, vide its order dated 13-04-2022, decided the issue in favor of the assessee by holding that TNMM was the most appropriate method. Accordingly, it directed the TPO to benchmark the royalty transaction as per TNMM. The relevant observations of the Tribunal are as follows: 11.2. We have perused submissions advanced by both sides in light of records placed before us. We note that the functions performed by the assessee before us, and that of Toyota Kirloskar (supra) considered by Coordinate Bench of this Tribunal, being .

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Page 9 of 37 the sister concern, are identical in nature. Both these assessee are engaged in manufacture of automotive components, peculiar to automobile industry. The assessee before us aggregated all the international transaction by using TNNM as the most appropriate method to benchmark the international transactions. The Ld.TPO segregated management fees and royalty payment, which constituted major part of the transaction. The entire dispute before us, is in respect of the method used for benchmarking the royalty transaction by separately benchmarking it under PSM. 11.3. The overall margin computed by the assessee was at 5.26%. From the transfer pricing study, we note that the assessee paid Rs.105,317,196/- as royalty to the AE, for use of technical knowhow relating to manufacture and sale of automotive components. The net sales earned by the assessee for the year under consideration is Rs.4,61,06,57,812/-. Thus, the effective rate of royalty paid by the assessee to the AE is at 2.28% over net sales. We note that, the Ld.TPO computed the royalty rate by using profit split method at 3.19%. The Ld.TPO considered the profit split ratio of 2:3 wherein 40% split was considered to be the share of the AE. There is in the overall margin of 5.26% 2.28% over the net sales are paid as royalty to the AE by assessee. 11.4. We note that, Ld.TPO referred to the decision of Hon’ble Delhi bench in case of Global One India (P.)Ltd. vs. ACIT (supra). On perusal of this decision, we learn that, that was a case where, Global One India, out of highly integrated operations and deployment of assets and functions of different entities located in different geographical locations, for execution of one transaction, to be ultimately delivered by way of combined effort. It was under such circumstances that profit split method was necessary to be considered as the most appropriate method. 11.5. In the present facts of the case that technology is obtained from the evil witches used by assessee in its manufacturing activity as there is no involvement of the global entities in order to execute the transaction. We have perused the decision case of assessee’s sister concern referred to herein above, wherein, in identical circumstances, the Tribunal observed and held as under: “15. We have considered the rival submissions. We are of the view that the issue with regard to Most Appropriate Method in the case of assessee had already been settled by the Tribunal. The TPO as well as the DRP have not followed the aforesaid decision of the Tribunal on the ground that economic life of the technology had an impact on the MAM and that technology in question was to be used by start-ups and since the assessee was using the technology for a fairly long period of more than 5 years, it would not be proper to adopt the TNMM as the MAM, as the economic life of the technology would no longer exist. In our view, there is no basis for the TPO as well as the DRP to come to a conclusion that technology in question was to be used by a start-up. There is no basis for the TPO and DRP to come to a conclusion that the Assessee is a start up in manufacture of various parts for automobiles. The technology in question was that of TMC Japan. The technology is being used by the Assessee even today. There is no basis for the TPO/DRP's conclusion that the useful economic life of the technology would be only 5 years. In any event passage of time cannot be the basis to discard TNMM which is already held by the Tribunal and .

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Page 10 of 37 upheld by the Hon'ble High Court as no longer the MAM because the conditions necessary for PSM as MAM are not met in the case of the Assessee. Even going by Rule 10B(1)(d), there should be contribution by each of the parties to a transaction for earning profits from sale of goods or provision of services. Then the contribution of each of the parties is identified and the profit is split between those parties. In the case of the Assessee the technology is given by TMC, Japan for which royalty is paid. The use of the technology in manufacturing and the sale of the product so manufactured contribute to the profit of the Assessee and TMC, Japan has nothing to do with that. There is therefore absence the first condition for application of PSM as MAM. As submitted by the Assessee PSM is used as MAM only in a case involving transfer of unique intangible or in multiple inter-related international transactions which cannot be valued separately for determining the ALP. The OECD guidelines cited on behalf of the assessee clearly supports the aforesaid approach and the OECD guidelines in this regard reads as follows:— "Further reliance is also placed on OECD Guidelines, which clearly lay down the situations in which the PSM is selected as an appropriate method for benchmarking. The relevant extract from the OECD Guidelines (para 2.109) is as below: "A transactional profit split method may also be found to be the most appropriate method in cases where both parties to a transaction make unique and valuable contributions (e.g. contribute unique intangibles) to the transaction, because in such a case independent parties might wish to share the profits of the transaction in proportion to their respective contributions and a two-sided method might be more appropriate in these circumstances than a one-sided method. In addition, in the presence of unique and valuable contributions, reliable comparables information might be insufficient to apply another method. On the other hand, a transactional profit split method would ordinarily not be used in cases where one party to the transaction performs only simple functions and does not make any significant unique contribution (e.g. contract manufacturing or contract service activities in relevant circumstances), as in such cases a transactional profit split method typically would not be appropriate in view of the functional analysis of that party".

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Page 11 of 37 the commercial and financial relations between the associated enterprises, including an analysis of what each party to the transaction does, and the context in which the controlled transactions take place. That is, the accurate delineation of a transaction requires a two-sided analysis (or a multi-sided analysis of the contributions of more than two associated enterprises, where necessary) irrespective of which transfer pricing method is ultimately found to be the most appropriate. 2.126. The existence of unique and valuable contributions by each party to the controlled transaction is perhaps the clearest indicator that a transactional profit split may be appropriate. The context of the transaction, including the industry in which it occurs and the factors affecting business performance in that sector can be particularly relevant to evaluating the contributions of the parties and whether such contributions ale unique and valuable. Depending on the facts of the case, other indicators that the transactional profit split may be the most appropriate method could include a high level of integration in the business operations to which the transactions relate and /or the shared assumption of economically significant risks (or the separate assumption of closely related economically significant risks) by the parties to the transactions. It is important to note that the indicators are not mutually exclusive and on the contrary may often be found together in a single case. 2.127. At the other end of the, spectrum, where the accurate delineation of the transaction determines that one party to the transaction performs only simple functions, does not assume economically significant risks in relation to the transaction and does not otherwise make any contribution which is unique and valuable …….. " "2.147. Under the transactional profit split method, the relevant profits are to be split between the associated enterprises on an economically valid basis that approximates the divisi6n of profits that would have been anticipated and reflected in an agreement made at arm's length. In general, the determination of the relevant profits to be split and of the profit splitting factors should: Be consistent with the functional analysis of the controlled transaction under review, and in particular reflect the assumption of the economically significant risks by the parties, and Be capable of being measured in a reliable manner."

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Page 12 of 37 that the Assessee aggregated payment of royalty with the transaction of manufacturing as it was closely linked and adopted TNMM but that does not mean that the transactions are so interrelated that they cannot be evaluated separately for applying PSM. Further, the Assessee does not make any unique contribution to the transaction, hence PSM in this case cannot be applied.

18. Therefore, we are of the view that TNMM is the Most Appropriate Method in the case of assessee. The decision of the Tribunal in the earlier AY 2008-09 has also been upheld by the Hon'ble High Court of Karnataka in CIT v. Toyota Kirloskar Auto Parts (P.) Ltd. [IT Appeal No.104 of 2015, dated 16-7-2018], which was an appeal of the revenue against the order of Tribunal for AY 2008-09. The Tribunal has upheld TNMM as MAM from AY 2007-08 to 2011-12. In those AYs the dispute was whether TNMM or CUP was the MAM. It is for the first time in AY 2013-14 that the revenue has sought to apply PSM as MAM. In the given facts and circumstances, we are of the view that TNM Method is the Most Appropriate Method and the AO is directed to apply the said method in determining the ALP, after affording opportunity of being heard to the assessee. The grounds of appeal of the assessee are treated as allowed 11.5. We note that, the Ld.TPO in present facts of the assessee before us, used identical comparables in order to ascertain the transaction to be at arms length as it was used in case of the sister concerns case referred to herein above. There is no dispute that, factual metrics and background our identical and the nature of payment having considered identically by the revenue authorities in both these cases. We are therefore respectfully following the view taken by coordinate bench of this tribunal in case of Toyota Kirloskar (supra), we are of the view that TNM Method is the Most Appropriate Method and the Ld.AO/TPO is directed to apply the said method in determining the ALP, after affording opportunity of being heard to the assessee.

14.2 We further find that the above finding of the Tribunal was also applied in subsequent years, i.e., A.Y. 2015-16, 2016-17, and 2017-18, in IT(TP)A No. 2586/Bang/2019, 362/Bang/2021, and 722/Bang/2022, respectively, where the dispute similarly pertained to the appropriate method for benchmarking the transaction at arm's length price (ALP). From the above, it is evident that in the earlier assessment years, the revenue has accepted the payment of royalty to the parent company (TBC-Japan), but the dispute primarily revolved around the benchmarking of the royalty payment.

IT(TP)A No.1539/Bang/2024 Page 13 of 37 14.3 However, we note that in the year under consideration, the TPO changed the stance and reclassified the assessee as a contract manufacturer. Accordingly, the TPO held that the assessee was not liable to make royalty payments. The TPO also deemed the royalty payment a colorable device intended to reduce the tax liability of the flagship company of the Toyota Group in India, i.e., TKML, by diverting the royalty payment to the assessee company. Thereby the TPO disallowed the entire payment of royalty by taking the ALP at NIL.

14.4 We note that there is no change in the facts, circumstances, or functions of the assessee in the year under consideration compared to earlier years. Therefore, in our considered opinion, the principle of consistency should be applied. Accordingly, considering the ruling of the Tribunal in the assessee’s own case in previous years, as discussed in the earlier paragraph, we hold that TNMM should be adopted as the most appropriate method. The learned AO/TPO is directed to determine the ALP of the royalty payment in accordance with the said method. Hence, the ground of appeal of the assessee is partly allowed for statistical purposes.

15. The issue raised by the assessee in Grounds Nos. 14 to 18 of its appeal pertains to the action of the learned DRP/TPO/AO in benchmarking the interest on outstanding receivables.

16. During the assessment proceeding, the TPO has noticed that the assessee has outstanding receivable from its AEs for long time. The TPO opined that the delay in payment of receivables from the AEs constitutes an International Transaction under section 92B of the Act, which .

IT(TP)A No.1539/Bang/2024 Page 14 of 37 explicitly includes such deferred payments under the ambit of transfer pricing provisions, thereby warranting an Arm’s Length Price (ALP) determination.

16.1 The TPO rejected the assessee’s contention that the receivables transaction should not be separately benchmarked as it was part of an overall business arrangement with the AE. As such, the TPO noted that aggregation of transactions is permissible only when the underlying transactions are continuous, closely interlinked, and have a direct bearing on pricing. The burden of proving such linkage rests with the taxpayer, which, in this case, failed to provide substantial evidence to justify aggregation. Hence, the TPO proceeded with a transaction-by- transaction approach for benchmarking the delayed receivables.

16.2 The TPO also rejected the assessee claim regarding the delay in receivables was compensated through set-offs in other transactions. The TPO held that, as per OECD guidelines, a set-off does not inherently imply that both transactions are at Arm’s Length. The assessee failed to demonstrate with evidence that the delay was indeed adjusted through a corresponding benefit in any other transaction. The TPO observed that the set-off transactions must be independently benchmarked, which the taxpayer did not do. Hence, the TPO rejected the set-off argument and treated the delayed receivables as a separate International Transaction requiring an ALP determination.

16.3 Further, the TPO in determining the ALP for delayed receivables, adopted a comparative approach by considering the opportunity cost of funds to the taxpayer. Given that the delay in payments resulted in loss .

IT(TP)A No.1539/Bang/2024 Page 15 of 37 of potential interest earnings, the TPO benchmarked the interest rate using the average SBI PLR rate for domestic currency transactions (13.62% per annum for FY 2019-20) and a LIBOR-based mark-up for foreign currency transactions.

16.4 Accordingly, the interest adjustment was computed on an invoice- wise basis, considering the number of days by which payments were delayed beyond the agreed credit period. After adjusting for interest already charged by the assessee, the TPO determined a final adjustment of Rs. 1,32,593/- only.

17. Being aggrieved, the assessee preferred to file objection before the learned DRP.

IT(TP)A No.1539/Bang/2024 Page 16 of 37 18.1 The assessee also submitted that providing the credit period for payment against the sale of goods or services is ordinary business norms and such norms have been followed by it (assessee) on provision of services provided to the AEs as well as non-AEs without charging any interest on the excess credit period allowed.

18.2 The assessee further contended that the outstanding receivable from the AEs are arising from the services rendered, hence, the services render is the primary transaction and allowance of credit period against such rendering of services is the secondary. The transaction of rendering services is found on ALP. Accordingly, it was argued that once the primary transaction has been tested and found on ALP, then the transaction of nominal interest on extension of credit period cannot be disputed. The assessee in support of its argument placed reliance on the decision of Delhi Tribunal in case of Kusum Healthcare Pvt Ltd vs. ACIT in reported in 62 taxmann.com 79 and the decision of this tribunal in case of ACIT vs. Millipore (India) Ltd in IT(TP)A No 327/Bang/2015 reported in 80 taxmann.com 12 as well as various other case laws.

18.3 The assessee further submitted that a continuing debit balance does not constitute an international transaction under section 92B(1) of the Act, as it is merely a reflection of an unpaid invoice from an existing international transaction rather than a separate transaction. In a normal scenario, payments are not necessarily made immediately upon becoming due, as they are influenced by factors such as invoice processing time, agreed payment terms, and standard business practices. Since the impact of receivables is already factored into the .

IT(TP)A No.1539/Bang/2024 Page 17 of 37 sale price, there is no need for any separate compensation or transaction.

20.1 The learned DRP also referred the decision of Hon’ble Karnataka High Court in case of DCIT vs. AMD India Pvt Ltd in and Hon’ble Bombay High Court in case of Technimont Pvt Ltd. in ITA .

IT(TP)A No.1539/Bang/2024 Page 18 of 37 No. 487/Mum/2017 where it was held that allowing the extend credit period beyond the agreed/normal time would constitute independent international transaction.

20.2 The ld. DRP regarding the assessee’s contention that the TP adjustment shall be made on real transaction held that the theory of real income does not apply in the contexts of transfer pricing. In holding so, the learned DRP referred various case laws.

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24.1 Now, coming to the issue in respect of the rate of interest, we find relevant to refer the judgment of Hon'ble Bombay High Court in the case of Principal Commissioner of Income-tax-13, Mumbai v. Tecnimont (P.) Ltd reported in [2018] 96 taxmann.com 223 (Bombay) wherein it was observed that in cases where any business enterprise is required to pay interest on delayed payment, it would examine the cost of interest and if the same is higher, then the amount of interest payable on funds obtained locally, it would take a loan from local sources and pay the amounts payable for exports and expenses within time. Therefore, extending of credit beyond the normal period of sixty days is in substance a granting of loan to an AE so as to enjoy the funds, which .

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Page 20 of 37 the AE would otherwise have to repay within the period of sixty days. On this premise, the Hon'ble High Court upheld the Tribunal order for computing interest at LIBOR rates as the rate prevailing in country where the loan is received/consumed by the AE by observing that the same cannot be faulted. The relevant extract of the judgment reads as under: 7. We note the finding of fact by the Tribunal that no interest is charged by the respondent assessee from its AEs as well as its non-AEs for delayed payment of export receivable and expenses. Further finding of fact that operating margin earned by the respondent assessee in respect of its transactions with AEs is higher than that earned on transactions with non-AEs entities. Thus, keeping the above finding of fact, we proceed to examine the Revenue's challenge to the impugned order of the Tribunal. The entire exercise of determining the ALP in respect of the AE transaction is to arrive at the price which would be the normal price in competative conditions between non-AEs. In this case, it is only the notional interest which is being computed as in fact no interest is charged by the respondent for delayed payments universally i.e. from AEs and non-AEs. In cases where any business enterprise is required to pay interest on delayed payment, it would examine the cost of interest and if the same is higher then the amount of interest payable on funds obtained locally, it would take a loan from local sources and pay the amounts payable for exports and expenses within time. Therefore, extending of credit beyond the normal period of 60 days is in substance a granting of loan to an AE so as to enjoy the funds, which the AE would otherwise have to repay within the perod of 60 days. The aforesaid finding of ours also finds support from the question of law at Sr. No.2 as proposed by the Revenue. Thus, in these circumstances, in the facts of this case order of the Tribunal computing interest at LIBOR rates as the rate prevailing in country where the loan is received/consumed by the AE cannot in these facts be faulted as it is in line with the decision of this Court in Tata Autocomp Systems Ltd. (supra).

24.2 In view of the above, we hold that the PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate. Furthermore, the PLR rates are not applicable to loans to be re-paid in foreign currency. Respectfully following the judicial opinion stated supra, we are of the considered view that the ends of justice would be met by accepting the interest rate on similar foreign currency receivables/advances as LIBOR+200 points, by applying the .

IT(TP)A No.1539/Bang/2024 Page 21 of 37 credit period of thirty days or as per agreement or invoice. Accordingly, we direct the learned Assessing Officer/ learned TPO to re-compute the same. Hence, the grounds of appeal of the assessee are hereby allowed for statistical purposes.

25. The next issue raised by the assessee vide ground Nos. 19 to 24 of its appeal pertains to the disallowance of gratuity expenses under section 43B of the Act by the CPC and learned DRP failure to adjudicate CPC adjustments by stating that CPC adjustments are independent of scrutiny assessments. Additionally, the AO violated the principles of natural justice by making adjustments without issuing a show cause notice and failed to consider documentary evidence submitted by the assessee.

26. The necessary facts are that the assessee in the return of income filed for the year under consideration declared total income at Rs. 58,27,68,190/- only. The return of income was processed under section 143(1) of the Act wherein the CPC disallowed the claim of gratuity expenses for Rs. 5,13,01,761/- as per the provision of section 43B of the Act, thereby the CPC assessed the income of the assessee at Rs. 63,40,69,950/-. Subsequently the case of the assessee was selected for scrutiny assessment wherein certain addition on account of TP adjustment was made. The AO while finalising the draft assessment order computed the total income after taking into account the income computed under intimation order under section 143(1) of the Act and addition of TP adjustment.

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IT(TP)A No.1539/Bang/2024 Page 23 of 37 intimation under section 143(1) of the Act and was not a variation proposed by the AO in the draft assessment order passed under section 144C(1) of the Act. The learned DRP noted that the CPC determined the disallowance, not the AO, and since the DRP's jurisdiction is limited to the variations made by the AO, it cannot interfere in adjustments determined by the CPC.

29.1 The learned DRP emphasized that intimations under section 143(1) and regular assessments under section 143(3)/144C(1) of the Act are separate proceedings, and there is no automatic merger between them. Since the disallowance was made at the CPC level and not part of a scrutiny assessment, the assessee's recourse lies in filing of an appeal before the ld. CIT(A) rather than seeking relief from the DRP. In holding so, the learned DRP relied on a decision by the Hon’ble Bangalore ITAT in the case of Areca Trust vs. CIT(Appeal Unit), NFAC, New Delhi, which clarified that an appeal against intimations under section 143(1) must be filed before CIT(A), not the ld. DRP. Based on this reasoning, the ld. DRP concluded that no interference was warranted and rejected the assessee’s claim.

IT(TP)A No.1539/Bang/2024 Page 24 of 37 is a prima facie adjustment and not a variation proposed by the AO. The learned AR argued that the DRP failed to adjudicate the matter properly, holding that the adjustment made by the CPC arises from a separate proceeding and does not automatically merge with the scrutiny assessment before the AO. This approach denied the assessee an effective opportunity to present its case, especially since no show cause notice was issued before making the variation in the intimation. The principles of natural justice have, therefore, been violated.

31.1 Further, the ld. DRP erred in not considering the documentary evidence submitted by the assessee, which substantiates that the gratuity payment was actually made. The AO also failed to appreciate that the adjustment made in the intimation pertains to a payment that qualifies for deduction under section 43B of the Act. The learned AR emphasizes that once the payment has been made within the prescribed timeframe, the deduction should not have been disallowed.

31.2 The learned AR also submits that the DRP's conclusion that it lacks jurisdiction is incorrect, as the doctrine of merger of intimation order with the assessment order should have been applied in this case. The learned AR, therefore, urges us to grant appropriate relief by directing the AO to allow the deduction and rectify the unjust disallowance.

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33.1 In the present case, the assessee declared a total income of ₹ 58,27,68,190/- in its return, which was processed under section 143(1) of the Act by the CPC, resulting in a disallowance of ₹5,13,01,761/- towards gratuity expenses under section 43B of the Act. This adjustment increased the assessee’s income to ₹ 63,40,69,950/-. Subsequently, the case of the assessee was selected for scrutiny, and a draft assessment order under section 143(3) r/w Section 144C(1) of the Act was passed, which did not propose any variation with respect to the gratuity disallowance. However, while computing the total income, the AO mechanically adopted the adjusted income from the intimation under section 143(1) of the Act, which included the disallowed gratuity expense.

33.2 The learned DRP refused to adjudicate the assessee’s objection to this disallowance on the ground that the adjustment originated from the CPC’s intimation under section 143(1) of the Act, and not as a variation proposed by the AO under section 144C(1) of the Act. The learned DRP held that it lacks jurisdiction over such matters and relied on the decision .

IT(TP)A No.1539/Bang/2024 Page 26 of 37 of the Hon’ble Bangalore ITAT in Areca Trust vs. CIT (Appeal Unit), NFAC, which held that adjustments made under section 143(1) of the Act can only be appealed before the ld. Commissioner (Appeals), not the DRP.

33.3 However, we are of the considered view that such a mechanical segregation between proceedings under sections 143(1) and 143(3) of the Act ignores the principle of merger of orders. In our considered view once a regular assessment under Section 143(3) is made, the intimation under section 143(1) ceases to be relevant and merges with the assessment order, unless expressly sustained or modified by the AO. In this regard, we find support and guidance from the order of the coordinate bench of ITAT Delhi in case of South India Club vs. ITO reported in 163 taxmannn.com 479 wherein it was held as under: 12. Further we observe that the statutory notice u/s 143(2) was issued on 22.09.2019. Further notices u/s 142(1) were issued in order to proceed with the regular assessment. Accordingly, the assessment u/s 143(3) was completed. When regular assessment was completed and the relevant intimation issued u/s 143(1) will automatically merges with the assessment passed u/s 143(3). Therefore, it loses its relevance once the regular assessment is processed, and it is only an intimation towards the accuracy of the information submitted by the assessee. In the given case, the assessee has claimed deduction u/s 11 and failed to file the form 10B along with the ROI. Based on the above observation, the claim of the assessee was denied by the AO in sec.143(1) proceedings. Therefore, there is no denial of fact that AO can make the above disallowance, however, the validity of the intimation issued u/s 143(1) is limited to mere intimation of correctness and accuracy of the income declared in ROI and its accuracy based on the information submitted along with the ROI. It does not carry the legitimacy of an assessment. When the assessment was processed under regular assessment then it .

IT(TP)A No.1539/Bang/2024 Page 27 of 37 loses its individuality and merges with the regular assessment. We are in agreement with the findings of Ld CIT(A) that the intimation u/s 143(1) merges with the order passed u/s 143(3) of the Act and the appeal against the above intimation becomes infructuous. In our view, he should have stopped with the above findings and should not have proceeded to decide the issue on merits, because it is brought to his knowledge that the assessee has filed appeal against the regular assessment order. Therefore, he has travelled beyond the mandate. The issue of allowability of section 11 is already considered in the regular assessment and that issue is already in appeal before FAA. Therefore, reviewing the same is uncalled for.

13. Coming to the submissions of the Ld AR, the assessee also not disputing the fact that the intimation merges with the regular assessment when the proceedings are initiated u/s 143(3) of the Act. Therefore, the admitted fact that the appeal against the intimation is infructuous. The grievance of the assessee is that Ld CIT(A) has not stopped with the findings but gave findings on the merits. After considering the submissions, we are also of the view that the findings on allowability u/s 11 is uncalled. Particularly when the issue under consideration is under challenge before another Appellate Authority.

33.4 The Hon’ble Kolkata High Court in CIT v. Coventory Spring & Co. Ltd. 257 ITR 632 had taken the view that “initial intimation merges into regular assessment and once proceedings for regular assessment under section 143(3) are commenced, there cannot be any recourse to bring into existence any order under section 143(1)(a) whether originally or by rectification”. In the instant case, the AO, while finalizing the assessment under section 143(3) of the Act, adopted the total income computed in the intimation issued under section 143(1) of the Act. By doing so, the AO has effectively incorporated the disallowance into the assessment order. Therefore, the assessee is justified in raising the ground of appeal .

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Page 28 of 37 against the said disallowance before the appellate authority, including the DRP if the assessment route involved section 144C of the Act.

33.5 Moreover, the disallowance of gratuity expenses was factually and legally flawed. Section 43B allows deduction for gratuity expenses paid before the due date of filing return under section 139(1) of the Act. The assessee has provided evidence that the payment was made on 15th September 2020, i.e., before the due date, and the same is duly reported in the Tax Audit Report. The failure to consider this evidence, coupled with the absence of a show cause notice or opportunity of hearing, amounts to a breach of natural justice. The CPC as well as the AO should have taken into account this compliance before disallowing the expense.

33.6 We further note that identical issue was recently examined by this tribunal in the case of Ariba Technologies India Pvt Ltd vs. DCIT reported in 172 taxmann.com 304. The tribunal after examination of detailed decided the issue in favour of the assessee. The finding of the tribunal is extracted as under: 25. We have heard the rival contentions of both the parties and perused the materials available on record. From the preceding discussion we note that the controversy before us relates whether the adjustment made in the intimation order under section 143(1) of the Act can be agitated in the proceedings under section 143(3) of the Act or in the appeal proceeding arising out of assessment order under section 143(3) of the Act. In this regard, let us understand the scope of the provisions of section 143(1) of the Act. Section 143(1) of the Act deals with prima facie adjustments made during the processing of an income tax return before assessment. The adjustments that can be made under this section include:

1. 1. Mathematical Errors - Correction of any arithmetical or clerical errors in the return.

2. Incorrect Claims - Disallowance of incorrect claims that are apparent from the information provided in the return.

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4. Deduction Disallowance - If any deduction under Chapter VI-A (like 80C, 80D, etc.) exceeds the permissible limit.

5. Mismatch in Income & Form 26AS/TDS Details - Any inconsistency between the income reported and the details in Form 26AS, AIS, or TDS certificates may be adjusted. 6. Disallowance of Exempt Income - If any income claimed as exempt does not meet the required conditions. 7. Mismatch in Tax Payments - Adjustments for advance tax, TDS, or self-assessment tax discrepancies. 25.1 The taxpayer is notified of any adjustments via an intimation under section 143(1) of the Act, and they are given an opportunity to respond before any demand is raised. 25.2 However, an intimation under Section 143(1) is not an assessment. It is merely a preliminary check of the return filed by the taxpayer and is done through an automated process. 25.3 In contrast, the Scrutiny Assessment under Section 143(3) is a detailed examination of the income tax return (ITR) by the AO to verify its correctness and ensure there is no understatement of income, overstatement of deductions, or tax evasion. To assess the correctness of income, deductions, exemptions, and tax liability, the AO issues several notices to the assessee in the form of questionnaire, show cause etc. The assessee is required to provide supporting documents, explanations, and evidence as demanded by the AO. This may include books of accounts, bank statements, invoices, agreements, etc. After examining all details, the AO may either accept the return as filed, or Make additions/disallowances, leading to higher tax liability. 25.4 From the above, there remains no ambiguity to the fact that the intimation under section 143(1) of the Act is not an assessment order. But any adjustment made under section 143(1) of the Act can be challenged either by filing rectification application under section 154 of the Act or by way of filing appeal before the learned CIT(A) under section 246 of the Act. Thus, as per the provisions of law the right course of action for the assessee is either to file rectification application under section 154 of the Act or appeal under section 246 of the Act. The assessee is required to choose the right course of action diligently which depends upon different facts and circumstances. 25.5 Nevertheless, the object for making the adjustment in the intimation under section 143(1) of the Act or framing the assessment under section 143(3) of the Act is to determine the income and tax liability correctly as per the provisions of law. 25.6 It is also important to note that in the present case the adjustment made under section 143(1) of the Act has been incorporated in the assessment framed under section 143(3) r.w.s. 144C of the Act. Thus, a question arises whether there is double demand in the records of the Department for the adjustment made under the provisions of section 143(1) of the Act as well as in the assessment framed under section 143(3) of the Act.

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Certainly, there can't be double demand for the same item of the disallowance or the addition. 25.7 Admittedly the adjustments are made by the CPC under section 143(1) of the Act whereas the assessment is framed by NFAC. However, the NFAC is not unknown to the adjustment made by the CPC i.e. automated process under section 143(1) of the Act. Therefore, we are of the view that the NFAC should have taken into cognizance of the adjustment made by the CPC in the intimation generated under section 143(1) of the Act especially in the circumstances where the assessee has brought to the notice to the NFAC about such adjustment. By doing so, the multiple proceedings can be avoided which are certainly cumbersome for the assessee. 25.8 As regards the principles laid down by Bangalore Tribunal in the case of Areca Trust (supra), we note that the assessee in the said case has preferred an appeal before the learned CIT(A) against the adjustment made under section 143(1) of the Act which was subsequently withdrawn by the assessee as the case of the assessee was picked up under scrutiny. In this background the Tribunal, has denied accepting the issue raised in the intimation under section 143(1) of the Act. It is because, once the assessee has withdrawn the appeal filed before the learned CIT(A), the issue arises from the intimation under section 143(1) of the Act reached to the finality. However, the facts of the case on hand are different in as much as the assessee has not filed any appeal before the learned CIT(A) under the bona fide belief that the matter may picked up under scrutiny. Furthermore, the assessee has brought to the notice of the NFAC about the adjustment made under section 143(1) of the Act which can be verified from the details available on pages 367 to 371 of the appeal set. 25.9 We further find that the Jodhpur Tribunal in the case of Akbar Mohammad v. ACIT [IT Appeal Nos. 108 & 109(Jodh) of 2021, dated 31-1- 2022] in the identical facts and circumstances held as under: 6. We have considered the submission of both the parties and perused the material available on record. In the present cases, it is not in dispute that the assessee deposited the contribution of PF & ESI belatedly in terms of section 36(1)(va) of the Act. However, the said deposits were made prior to filing of return of income u/s 139(1) ofthe Act. 6.1 Of course, it is a case in point that the assessee did not file any appeal against the intimations passed us 143(1) of the Act and the Ld. Sr. DR is right to the extent that the assessee cannot be given relief for that reason. However, it is also a settled law that the assessee cannot be taxed on an amount on which tax is not legally imposable. Although, the assessee might have chosen a wrong channel for redressal of his grievance, all the same, it is incumbent upon the Tax authorities to burden the assessee only with correct amount of tax and not to unjustly benefit at the cost of tax payer. Therefore, in the interest of substantial justice, we deem it expedient to restore the issue to the file of the Assessing officer with a direction to pass appropriate orders deleting the addition / disallowance after duly considering the settled judicial position in this regard, which have been decided in the three cases as enumerated above in Para 25.10 In view of the above, we are not inclined to encourage the assessee not to prefer separate appeal against the intimation generated under section 143(1) of the Act but in the interest of justice and fair .

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Page 31 of 37 play we accept the issue arising from intimation under section 143(1) of the Act in the proceedings arising under the provisions of section 143(3) r.w.s. 144C of the Act.

33.7 It is also pertinent to highlights that the statute does not permit the collection of tax beyond what is legitimately due from the assessee. Taxation must be based on liability established under the law, and merely because of a procedural lapse, an assessee cannot be compelled to pay tax that it is not legally required to pay. In this case, the assessee has provided documentary evidence showing that the gratuity payment was made before the due date of return filing, making it allowable under section 43B of the Act. Therefore, in our considered opinion merely the fact that the impugned disallowance was made in the intimation order u/s 143(1) of the Act and the assessee has not preferred appeal against the said intimation does means that assessee should be charged with taxes which he is not liable.

33.8 In view of the above detailed discussion and following the judicial precedence we hold that the disallowance made under section 143(1) of the Act, having been adopted and merged into the regular assessment under section 143(3) of the Act, is very much appealable in the context of the present proceedings. The disallowance of gratuity expenses is unjustified, both on merits and on procedural grounds.

33.9 Accordingly, we direct the AO to delete the disallowance of ₹5,13,01,761 made under section 43B of the Act towards gratuity expenses, as the payment was made within the statutory time and is otherwise allowable. Hence the ground of appeal of the assessee is hereby allowed.

IT(TP)A No.1539/Bang/2024 Page 32 of 37

34.1 The necessary facts are that the assessee in the return of income, filed for the year under consideration, claimed relief of foreign tax credit for Rs. 49,75,683/- which was disallowed by the CPC while processing the return under section 143(1) of the Act. Further, the AO after passing the final assessment order computed the total tax liability of the assessee and the AO relying on 143(1) intimations also not allowed the claim of the foreign tax credit to the assessee.

IT(TP)A No.1539/Bang/2024 Page 33 of 37 the AO, while completing the final assessment, also did not grant the foreign tax credit and relied on the earlier disallowance made under section 143(1) of the Act.

38.1 The assessee has submitted that the foreign tax credit was rightfully claimed in accordance with the provisions of the Act, and the same was duly supported by the filing of Form 67, as mandated under Rule 128 of the Income Tax Rules. The disallowance appears to have been made without examining the merits of the supporting documents or the claim itself.

38.2 In view of the above facts and in the interest of justice, we find merit in the assessee’s contention. If the requisite documentation, including Form 67, was furnished within the prescribed time, then the assessee is entitled to the credit of taxes paid in foreign jurisdictions in accordance with the applicable legal provisions. Accordingly, we direct the AO to verify the claim afresh, examine the availability and timeliness of Form 67 and other supporting records, and grant the appropriate foreign tax credit as per law. Hence, the ground raised by the assessee is allowed for statistical purposes.

39.1 The necessary facts are that the AO in the computation sheet forming part of final assessment order under section 143(3) r.w.s.

IT(TP)A No.1539/Bang/2024 Page 34 of 37 144C(13) of the Act besides computing final income tax liability of the assessee also computed dividend distribution tax liability of the assessee at Rs. 14,52,55,114/- and charged interest on the same as per the provisions of section 115P of the Act at Rs. 8,11,53,068/- only.

43.1 The assessee has submitted that the said amount of DDT had already been discharged on 26th June 2019, and in support of this, a copy of the DDT payment challan has been filed as additional evidence .

IT(TP)A No.1539/Bang/2024 Page 35 of 37 before us. It is the assessee’s contention that the failure to allow the credit for the DDT already paid has resulted in an unjustified computation of interest under section 115P of the Act.

43.2 In light of the submissions made, we are of the view that the matter requires proper verification by the AO. If the DDT payment as claimed was indeed made by the assessee on the date stated above and is supported by the challan and corresponding entries in the assessee’s records, then the credit of such payment must be granted and the consequential levy of interest under section 115P of the Act should be appropriately revised. Accordingly, in the interest of justice and fair-play, we restore the issue to the file of the AO with a direction to verify the DDT payment claim made by the assessee and allow the credit as per law. The AO shall also recompute interest under section 115P of the Act accordingly after granting due credit for the DDT, if found in order. Hence, this ground of appeal is allowed for statistical purposes.

44. The issue raised by the assessee through ground No. 30 of its appeal is that the AO levied ad-hoc interest of Rs. 2,35,955/- without having any basis.

44.1 The learned AR before us submitted that in computation sheet forming part of final assessment order an interest of Rs. 2,35,955/- was charged without assigning any reason. Accordingly, the learned prayed before us that the AO should be given directions to provide appropriate relief.

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46.1 The learned AR has contended that the interest figure appears arbitrary and unsubstantiated, and no basis or reference to any applicable section of the Act has been provided to justify such a levy. In the absence of a clear basis or statutory provision supporting the computation, the addition of interest in an ad-hoc manner cannot be sustained. Accordingly, in the light of the above, we find merit in the assessee’s contention. The levy of interest must be supported by a specific provision of law and a clear rationale computation. We, therefore, set aside this issue to the file of the AO with a direction to verify the nature and basis of the interest amount of Rs. 2,35,955/- and either provide a detailed justification for the same or delete the levy, if found unsubstantiated. Accordingly, this ground of appeal is allowed for statistical purposes.

IT(TP)A No.1539/Bang/2024 Page 37 of 37 Order pronounced in court on 9th day of May, 2025