M/S CONTINENTAL AUTOMOTIVE COMPONENTS INDIA PVT LTD ,BANGALORE vs. ASSISTANT COMMISSIONER OF INCOME TAX CIRCLE-2(1)(1), BANGALORE

Per Chandra Poojari, Accountant Member

This appeal by the assessee is directed against the order of the ACIT, Circle 2(1)(1), Bangalore dated 31.1.2017.

(i) Manufacturing segment The assessee is engaged in the manufacture of auto-electrical components which include instrument clusters, engine systems,

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speed sensors, airbag controllers, anti-lock braking system etc. for the automobile industry. (ii) Trading segment The assessee’s operations in this segment primarily relate to the trading of dashboard instruments, tachographs, sensors and other allied components for the automobile industry. (iii) Services segment In the services segment, the assessee renders application / specific services to its Associated Enterprises (“AEs”) with regard to development of software. 3. During the AY 2012-13, several international transactions took place between the assessee and its AEs, including purchase of raw materials for the manufacturing segment and the aforesaid provision of SWD services and in the course of assessment, the AO made a reference to the TPO for examination of the arm’s length price of the aforesaid transactions.

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expenses to the extent incurred by the assessee of Rs. 2,62,34,907/- and R&D expenses to the extent of Rs. 26,39,28,539 as a deduction on the ground that the same has been considered a part of the operating cost for computing the margin for manufacturing segment.

MANUFACTURING SEGMENT

Sl. Particulars Amounts No. (in Rs.) 1. Purchase of raw material and components 77,90,18,698 2. Payment towards technical know-how fee 43,08,67,934 3. Sale of automotive components 21,77,46,807 4. Payment towards Research and development 23,60,81,090 fees 5. Payment towards services availed 56,66,07,292 6. Purchase of capital assets 7,65,63,855 7. Purchase of automotive components for 1,68,51,69,923 trading 8. Services revenue 1,04,36,85,278 9. Interest on loan paid 1,98,12,390 10. Reimbursement of expenses 9,52,04,249 11. Recovery of expenses 1,25,66,823 12. Trade Payables 2,06,64,81,202

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Net mark-up on cost earned by the Appellant As per the TP study:

Operating Income Rs. 484,00,60,000/- Operating Cost Rs. 453,33,80,000/- Operating Profit (Op. Income – Op. Cost) Rs. 30,66,80,000/- Net mark-up (OP/OR) 6.34%

As reflected in the TP Order:

Operating Income Rs. 483,10,60,000/- Operating Cost Rs.539,43,70,000/- Operating loss (Op. Income – Op. Cost) Rs.-56,33,10,000/- Net mark-up (OP/OR) -11.66%

• costs associated with unutilised capacity. • costs on account of high customs duty 12. On making the above mentioned adjustments, the assessee arrived at a margin of 6.34% as against -11.66% arrived at by the TPO. Though the TPO accepted the comparables selected by the assessee, he did not grant an adjustment for under-utilisation of capacity and an adjustment for expenses incurred towards customs duty. The TPO also treated amortization of goodwill as an operating expense while computing the margin of the Appellant.

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Filters applied by assessee in its TP study:

Step Description 1. Companies for which the latest data available was for a period ended prior to 31.03.2010 – rejected 2. Companies reporting net sales >Rs. 1 crore – selected 3. Companies with positive net worth – selected 4. Companies reporting average manufacturing income/average net sales>50% - selected 5. Companies which were functionally comparable – selected 6. Companies with related party transactions less than 10% of sales – selected

Comparables selected by assessee and their arithmetic mean:

Sl. Name of the company Weighted No. Average Margin (%) 1. Automotive Stampings & 3.06 Assemblies Ltd 2. Bajajsons Ltd 4.87 3. Bharat Gears Ltd 6.94 4. JMT Auto Ltd 10.69 5. M&M Auto 8.03 6. Rambal Ltd 8.07 7. Rasandisk Engineering Inds. India 5.30 Ltd 8. Triton Valves 7.78 9. Wheels India Ltd 5.48 10. Mubea Suspension India Ltd 5.34 11. Ring Plus Aqua Ltd 10.83 Average 6.94

Operating Revenue (“OR”) 4,83,10,60,000 Operating Cost (“OC”) 5,39,43,70,000 Operating Profit (“OP”) -56,33,10,000 OP/OR -11.66% OP/OC -10.44% Arm’s length OP/OR 6.94%

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Arm’s length OP 33,52,75,564 Arm’s length cost 4,49,57,84,436 Adjustment (OC – arm’s length cost) 89,85,85,564

Ground No.4 : Capacity utilization

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assessee to acquire new customers. This resulted in underutilization of the production capacity in the factory, resulting in low utilization of the available capacity for the FY 2011-12 to manufacture the products. The assessee operated at 40.39% of its installed capacity whereas the comparable companies chosen by the assessee operated at an average of 77.42%. It is evident from the capacity utilization of 40.39% that the assessee had under-utilized its capacity considering low demand for its products. Hence, the assessee could not manufacture at optimal capacity and recoup the fixed expenses for the year and the adjustment for under-utilization of capacity is warranted.

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profit arising from such transaction in the open market. Nowhere does the Rule 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. It is 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 and, 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 ITO reported in [2017] 79 taxmann.com 303 (Mumbai - Trib.). This 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)

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allowed. However, in the assessee’s case, it has provided all information practically possible. Sufficient evidence has been provided in the form of capacity data of comparable companies as well as industry average from the Federation of Indian Chambers of Commerce & Industry (“FICCI”) survey report. Hence principally capacity utilization adjustment should have been granted. The assessee also relies on the following judicial precedents in this regard:-

• 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. DCIT reported 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) 21. Without prejudice to the above contentions on producing relevant data wherever practically possible by the assessee, since the revenue is of the opinion that the data provided by the assessee is unreasonable and inaccurate, the ld. AR submitted that the AO can exercise his powers under Section 133(6) of the Act to collate the information on capacity details of the comparable companies such as actual capacity in units, installed capacity, break up of fixed and variable cost, product wise segmental profitability (if any) and provide the assessee an opportunity by sharing the details so obtained on the comparable companies, and accordingly grant the adjustment for capacity under-utilized. Similar contentions have been upheld by this Tribunal in the case of IKA India Private Limited v. ACIT reported in [2019] 101 taxmann.com 276 (Bangalore). It was therefore

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submitted the adjustment for capacity utilisation as made by the assessee in its TP study be upheld. In the alternative, as submitted above, since the respondent-revenue is well within its powers to call for details from the comparable companies, such course may be adopted and the adjustment be granted.

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comparables and whatever data relied upon by the assessee for seeking capacity utilization adjustment was either unreliable or incorrect. When fixed cost itself is incurred only for a part of the year the same cannot be adjusted for differential capacity utilization”.

“5. We have perused submissions advanced by both sides in the light of records placed before us. Indian transfer pricing regulations and OECD guidelines requires adjustment to be made in case of material differences in transactions or enterprise being compared, so as to arrive at a more reliable margin. And any adjustments as per Rule 10B(3) requires to be made in case of uncontrolled transaction. However, in a case where appropriate adjustment cannot be made to uncontrolled transaction due to lack of information/data, then in order to read provisions of transfer pricing regulations in harmony, adjustments should be made in case of tested party. 5.1 On perusal of decision of Co-ordinate Bench of this Tribunal in India Pvt. Ltd. vs DCIT (supra), it is observed that has been considered by observing as under: “The Indian transfer pricing regulations, OECD Guidelines and the US transfer pricing regulations call for an adjustment.to be made in case of material differences in the transactions or the enterprises being compared so as to arrive at a more reliable arm's length price/ margin. While the Indian transfer pricing regulations refer to the adjustments on uncontrolled transactions, however the same has to be read with Rule 10B(3) of the Rules which clearly emphasizes the necessity and compulsion of undertaking adjustments. Hence in case appropriate adjustments cannot be made to the uncontrolled transaction, due to lack of data, then in order to read the provisions of transfer pricing regulations in harmony, the adjustments should be made on the tested party. In the

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following decisions it has been held that adjustment to the profit margins have to be made on account of underutilization of capacity: (i) In the case of Mando India Steering Systems (P.) Ltd. v. Asstt. CIT [2014] 45 taxmann.com 160/ 149 ITD 284 (Chennai Trib) the Tribunal upheld the contention of the taxpayer for making a suitable adjustment on account of idle capacity for the purpose of margin computation. The relevant extract is reproduced as below: "10. We are of the considered view that under- utilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production." (ii) In the ruling of Dy. CIT v. Panasonic AVC Networks India Co. Ltd. 12014] 42 taxmann.com 420/ 63 SOT 121 (URO) (Delhi - Trib.) it was held that:— "5. ……….. Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment." (iii) In the case of Biesse Mfg. Co. Ltd. v. Asstt. CIT 12016] 69 m 428 (Bang. - Trib.) the Tribunal held as follows: “10.4.1 We have heard the rival contentions and perused and carefully considered the submissions made and material on record; including the judicial pronouncements cited. The issue for consideration is whether adjustment for under- utilisation of capacity is allowable in the case on

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hand and if so, the manner of computation thereof and the quantum of adjustment ……….. 10.4.5 In the above cited case of the Mumbai Tribunal i.e. Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity underutilisation can be granted. ……….. Following the decision of the ITAT, Mumbai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment for capacity underutilisation can be granted " (iv) In the recent case of GE Intelligent Platform (P.) Ltd. (IT(TP)A No. 148/Bang/ 2015 and 164/Bang/ 2015) for AY. 2010-11 was held as follows:- "8 ……. now the law is quite settled to the extent that once there is unutilized capacity or men power, such underutilization impacts margin and therefore, the adjustment should be made while computing the ALP …….. If the underutilization is more than average underutilization of the industry then necessary adjustment is required to be made to the margin of computing ALP " 29. Moreover, the above argument of the assessee for grant of capacity utilisation adjustment is also supported by the following decision of Bangalore ITAT in the case of Genisys Integrating Systems (India) (P.) Ltd. v. Dy. CIT 12012] 20 tcvcmann.com 715/ 53 SOT 159. Relevant extract of the decision is under:— "15.2 We agree with this contention of the counsel for the assessee. All the comparables have to be compared on similar standards and the assessee cannot be put in a disadvantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure. The all consider this fact also while deter mining the ALP and TP adjustments. With these directions, the appeal of the disposed of."

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30.1 The reliability and accuracy of adjustments would largely depend of reliable and accurate data. For certain types of adjustments, relevant data for comparables may either not be available in public domain or may not be reliably determinable based on information available in public domain, whereas, it may be possible to make equally reliable and accurate adjustments on the tested party (whose data would generally be easily accessible). 31. In such a scenario, one has to resort to the provisions of Rule 10B(3)(ii) which provides for making "reasonably accurate adjustments" for eliminating any material differences between the two transactions being compared. The purpose or intent of the comparability analysis is to examine as to whether or not, the values stated for the international transactions are at ALP i.e., whether the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don't restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/ transactions as per sub-clause (i) of rule 10B(1)(e) of the Rules itself The absence of specific provision in Rule 10.13(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been. upheld in the following decisions:— • Capgemini India Pvt. Ltd. v. Asstt. CIT 12014 33 taxmann.com 5/120141 147 ITD 330 (Mum. - Trib.) • Demag Cranes & Components (India) (P.) Ltd. v. Dy. CIT 12014 17 taxmann.com 190/49 SOT 610 (Pune) 32. As far as data of comparable companies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilization adjustment.

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(Emphasis Supplied) 35. Accordingly, we direct the TPO to exercise powers under section 133(6 • the Act to call for information on capacity utilization of the companies such as — • Installed Capacity, • Actual production in Units, • Break up of Fixed Cost and Variable Cost; • Segmental/ product wise information, if any. 36. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No. 7 is decided accordingly. Respectfully following aforestated observations, we direct Ld.TPO to exercise powers under section 133(6) of the Act and call for relevant information on capacity utilisation in case of comparables finally selected. Needless to say that details so collected by Ld.TPO shall be provided to assessee and then to provide consider the issue as per law. Accordingly this ground raised by assessee stands allowed for statistical purposes.” 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 AO/TPO is directed to obtain the same directly from the comparable companies and decide the

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issue afresh, after affording opportunity of being heard to the assessee. Accordingly, this issue is remitted to the AO/TPO.

Ground No.5 : Customs Duty Adjustment 25. The grievance of the assessee by this ground is that the DRP erred in not granting adjustment towards custom duty expenses. 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 is 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 vis-a-vis 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 TPO also observed that the import duty is a part of the cost of material which is always included at the time of pricing of the product and also that the assessee ought to have considered the customs duty component payable while negotiating the price at which the raw materials are imported.

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

Sl. Name of the company Imports/Total No. purchases (%) (3 year average) 1. Automotive Stampings & Assemblies 0.57 Ltd 2. Bajajsons Ltd 5.92 3. Bharat Gears Ltd 2.62 4. JMT Auto Ltd 1.54 5. M&M Auto 0.53 6. Rambal Ltd 2.10 7. Rasandisk Engineering Inds. India Ltd 4.61 8. Triton Valves 10.81 9. Wheels India Ltd 8.63 10. Mubea Suspension India Ltd 0.02 11. Ring Plus Aqua Ltd 4.75 Average import consumption 3.83

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a. Adjustments are to be made to the margins of the comparable companies to account for differences which could materially affect the amount of net profit margin in the open market. In the case of the assessee, it is the business model by which the assessee imports most of its raw materials from its AEs. The assessee company manufactures goods and sells in India out of raw materials procured from its AEs. This import duty is not a onetime cost which would affect the company's margin as an extraordinary event. b. Import duty per se does not call for an adjustment. It requires to be seen whether the import is necessitated by certain factors beyond the control of the assessee company. If it is the normal business model of the assessee to import goods, it is not an extraordinary event affecting its margin. c. The higher percentage of import content in the assessee's production is a conscious decision taken by the assessee keeping in mind all commercial considerations including the obvious benefits of better quality which is bound to reflect in higher sales margin. d. Import duty is part of the cost of material which is always taken into account in pricing a product. If the individual elements of cost were to be separately adjusted for differences between the tested party and the comparables, then the profit margin of all the companies would become uniform. e. The assessee company ought to have considered the customs duty component payable while negotiating the

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price at which the raw materials were imported from the AEs. 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:-

“5. Before us, ld. 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. Asstt. CIT [2016] 73 taxmann.com 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 Skoda

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Auto India p Ltd 122 TTJ 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, 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 public

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domain. 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 was 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 permissible 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. This additional argument was not available before the 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 to the file of the TPO for fresh adjudication in the light of our above observations." 38. The perusal of the impugned orders shows that the above cited guidelines by way of decision of this bench of the Tribunal in the case of Skoda Auto India p Ltd (supra) were not available to the revenue authorities. Therefore, we are of the opinion, the issue should be set aside to the files of the TPO with direction to examine the claim of the assessee relating to the import cost factor and eliminate the difference if any. However, the TPO/AO/DRP shall see to it that the difference in question is 'likely to materially affect' the price/profit in the open market as envisaged in

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sub rule (3) of Rule 10B of the Income tax Rules, 1962. Accordingly, ground 4(b) is allowed pro tanto.' Accordingly, we direct the A.O. to give suitable adjustment against the custom duty component while determining the ALP.' Hence, to bring uniformity, the customs duty was to be eliminated from the comparable price also to arrive at correct PLI. Accordingly, we remit the issue to the file of AO for fresh consideration.” 31. In view of the above finding of the Tribunal in Gates Unitta India Company (P.) Ltd. (supra), we are inclined to remit this issue to the AO/TPO with similar directions.

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and hedging cost will vary depending on the risk management policy and on the hedging cost a company is willing to bear. The foreign exchange fluctuation computed as per Accounting Standards (“AS”) 11 takes into account the realization loss/gain (fluctuation due to differences between invoice and payment exchange rates) and revaluation loss/gain (translation of closing balances at the year-end exchange rate). However, such exchange fluctuation does not take into account any adverse exchange fluctuation due to depreciation of Indian currency on a year-on-year basis. The adjustment now being sought for by the assessee is on account of the foreign exchange fluctuation loss which is embedded in the raw material import cost. It is submitted 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.

% Average Euro to Financial year depreciation/ depreciation/ INR rate appreciation appreciation 2008-09 65.45 - 2009-10 67.37 2.94% (3.95%) 2010-11 60.06 (10.85%) 2011-12 66.29 10.37% 10.37% 2012-13 70.03 5.64% 1.42% 2013-14 80.66 15.18%

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2014-15 78.15 (3.11%) 2015-16 71.78 (8.15%) 2016-17 73.77 2.77% 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% (0.98%) 2010-11 45.51 (4.54%) 2011-12 47.86 5.16% 5.16% 2012-13 54.19 13.23% 2013-14 60.33 11.34% 2014-15 61.03 1.15% 5.26% 2015-16 65.36 7.10% 2016-17 67.12 2.68% 2017-18 64.48 (3.94%) 35. The ld. AR submitted that during the FY 2011-12, there was an abnormal depreciation in the value of Euro and USD as against the average movement for the preceding periods. This has resulted in a higher outflow of INR for the same value of Euro and USD which was transacted in the previous year. Although there was no significant increase in the price of imports as compared to the previous year, the foreign exchange rate fluctuations has also contributed towards increased material costs. Therefore, an adjustment for the abnormal impact due to foreign currency fluctuation during the year has to be considered on the value of import purchases made during the year. He highlighted the following points that necessitate the adjustment to the Appellant’s cost on account of foreign exchange fluctuations:

Higher Import Content of the assessee vis-à-vis comparable companies:

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the comparable companies selected in the transfer pricing documentation by the assessee and also the comparable companies selected by the TPO.

“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 Motonic India Automotive (P.) Ltd. (supra) in for assessment year 2009-10 vide order dated 17.08.2016 wherein held that:—

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"9. We find force in the argument of the ld. 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. ACIT in ITA No.5297/Del/2011 for the assessment year 2007-08 and DHL Express (India) Pvt. Ltd. v. ACIT 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.

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“15. Assessee has challenged the findings returned by TPO/DRP treating amortization of goodwill as not extra ordinary in nature. It is the case of the assessee that goodwill is on account of acquisition of units through slump sale under Business Transfer Agreement and in these circumstances, amortization of goodwill is an extra ordinary item and is not pertaining to the regular operation of the taxpayer, hence non-operating in nature.

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play and therefore to make an adjustment including the non-AE transactions is erroneous and contrary to the provisions of the Act. Reliance is placed on the following decisions in support of the above contention of the Appellant: • 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) • 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.)

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Nature of international transactions Reference Amount in INR Purchase of raw materials and components less of returns A 77,90,18,698 Payment of Technical Knowhow B 43,08,67,934 Payment of royalty C 23,60,81,090 Availing of services D 2,78,47,449 Production Support Service E 2,64,51,066 Shared support services F 51,23,08,777 Total value of international transactions G=SUM(A:F) 2,01,25,75,014 Total adjustment under manufacturing segment H 38,91,70,408 Total Operating Cost (from TP Order) I 5,39,43,70,000 Adjustment restricted to international transactions J=(H*G)/I 14,51,94,831

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Operating cost Purchase of raw materials 77,90,18,698 and components Technical knowhow 43,08,67,934 Research and 26,39,28,539 development licence fees Payment towards services 56,66,07,292 availed TOTAL 204,04,22,463 Operating revenue Sale of automotive 21,77,46,807 components

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analysis. Hence, reliance placed by the assessee on the decisions is rejected by the revenue authorities.

SOFTWARE SEGMENT

“24A. The learned AO/learned TPO/learned DRP erred in treating the amortization of goodwill arising out of the purchases by the Appellant from Siemens Limited pursuant to the purchase of business by the Appellant from Siemens Limited pursuant to the Business Purchase Agreement dated 23 November 2001 as operating in nature for the purpose of margin computation of the Appellant’s services segment.” 56. Application for admission of additional ground is filed submitting that this ground was raised in ground No.7 in the manufacturing segment before the lower authorities and the Tribunal, however, due to oversight the same was not raised specific to services segment, which is a bona fide mistake and the same may be admitted. We have considered the rival submissions, perused the record and are of the view that the additional ground now

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raised before us requires no fresh investigation into facts and is borne out of material available on record. Accordingly, following the Hon’ble Supreme Court judgment in the case of M/s National Thermal Power Co. Ltd. Vs. CIT, 229 ITR 383 (SC), the additional ground is admitted for adjudication.

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Larsen and Toubro Infotech Ltd. (‘L&T’) & Persistent Systems Ltd.

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account of ownership of marketing intangibles and intellectual property rights. L&T has been consistently excluded from the final list of comparables in the cases of assessees similar to the Appellant Accordingly, the Appellant submits that the company is a product company having significant intangibles and is thus not comparable to captive software service providers such as the Appellant. Detailed submissions in this regard are made at pages 320-327and pages 642-645 of the paperbook. He submitted that the DRP, however, failed to properly appreciate the assessee’s submissions in this regard and thereby upheld its inclusion in the list of comparables.

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such differences, if any, is taken care of while computing the mean margin of the comparable companies. Accordingly, the objection with regard to the above company is not acceptable, and the selection of the same by the TPO is accordingly to be upheld.

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(including foreign exchange loss) which is provided in Note P(i) and P(ii) of the Annual Report:-

EXPENSES Employee benefit expenses O(i) 17,700,804,103 Operating expenses O(ii) 2,233,789,603 Sales, administration and O(iii) 3,466,224,349 23,400,818,255 Operating profit 6.284,714,851 Finance Cost 358,026,704

P. FINANCE COST P(I) Interest paid on Fixed loans 909,998 On others 75,544,203 Lease finance charges 397,440 76,851,641 P(ii) Exchange loss on borrowings (net) 281,175,063 Total finance cost 358,026,704

Persistent Systems Ltd. (Persistent)

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Intellectual Properties and has significant onsite revenues. However, the same was rejected by the TPO and upheld by the DRP.

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Consultants (P.) Ltd. v. ACIT (reported in [2018] 94 taxmann.com 97 (Bangalore - Trib.) and PCIT v. Cash Edge India P. Ltd reported in TS-262- HC-2016(DEL)-TP (order dated 04.05.2016) wherein, in the case of assessees placed similar to the assessee, this company was directed to be excluded. Consequently, it is submitted that Persistent is incomparable to the assessee and ought to be excluded from the list of comparables for the above and following reasons.

The turnover of Persistent Systems is significantly higher than the assessee and hence, Persistent Systems has to be rejected based on the application of the upper limit of turnover criteria. Persistent Systems fails related party transaction ("RPT") filter and therefore, it should be rejected. The Company has the presence of extraordinary events during the year. The learned Transfer Pricing Officer ("TPO") has erred in computation of markup of the Company. 71. The ld. DR submitted that this company was rejected on application of upper turnover filter and upheld the application of the related party transaction filter applied by the TPO. Hence, the contention regarding the turnover and related party transaction filter are not acceptable. With regard to the functions, on perusal of page no.164 of the Annual Report, it is noticed that "the company is predominantly engaged in outsource software product development services, the company offers complete product life cycle" which is further evident, from Note 21 to the financial statements, according to which the entire revenue is from sale of software services.

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Persistent System and Solutions Ltd., engaged in software development services, have been amalgamated, with effect from 01/04/2011, with the assessee company, the profit of 4.46 million and 89.08 million respectively of the above companies have been included in the profit and loss of the assessee company. However, both the above companies were mainly engaged in software development services, we are of the view that the work related to consultancy and system integration, in the case of Persistent e-Business Solutions Ltd., has not resulted in increase of profit of the company selected as comparable, considering the fact that profit of Persistent e-Business Solutions Ltd. is '44 lakhs, which works out to only 2.54% of the operating profit of 217.32 crores computed by the TPO. Accordingly, we do not find any infirmity in selection of the above company as a comparable.

“29. We have considered the rival submissions. In the case of Agilis Information Technologies India (P.) Ltd. (supra), this Tribunal considered the comparability of the 3 companies which the Assessee seeks to exclude from the final list of comparable companies chosen by the TPO. The functional profile of me

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Assessee and that of the Assessee in the case of Agilis Information Technologies India (P.) Ltd. (supra), is identical inasmuch as the said company was also involved in providing SWD services to its AE and the TPO had chosen some comparable companies which were also chosen by the TPO in the case of the Assessee for the purpose of comparability. In the aforesaid decision the Tribunal held on the comparability of the 3 companies which the Assessee seeks to exclude as follows:

(a) * ….. * …… * (b) Larsen & Tourbro Infotech Ltd., was excluded from the list of comparable companies by relying on the decision of the Delhi Bench of ITAT in the case of Saxo India (P.) Ltd. v. Asstt. CIT [2016] 67 taxmann.com 155 (Delhi - Trib.). The discussion is contained in paragraphs 4.8 to 4.10 of the Tribunal's order. The Tribunal held that L & T Infotech Ltd., was a software product company and segmental information on SWD services was not available. The Tribunal also noticed that the appeal filed by the revenue against the tribunal's order was dismissed by the Hon'ble Delhi High Court in ITA No.682/2016. (c) Persistent Systems Ltd., was excluded from the list of comparable companies on the ground that this company was a software product company and segmental information on SWD services was not available. The Tribunal in coming to the above conclusion referred to the decision rendered by ITAT Delhi Bench in the case of Cash Edge India (P.) Ltd. v. ITO ITA No.64/Del/2015 order dated 23.9.2015 and the decision of Hon'ble Delhi High Court in the case of Saxo India Pvt. Ltd. (supra). The findings in this regard are contained in Paragraphs 4.14 to 4.16 of its order. 30. Respectfully following the decision of the Tribunal we hold that the aforesaid 3 companies be excluded from the final list of comparable companies for the purpose of arriving at the arithmetic mean of comparable companies for the purpose of comparison with the profit margins. In this regard we are also of the view that the plea of the learned DR for a remand of the issue to the DRP on the ground that the DRP has not given any reasons in its directions cannot be accepted. The DRP bas endorsed the

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view of the TPO in its directions and therefore the reasons given by the TPO should be regarded as the conclusions of the DRP.” 75. In view of the above decision of the Tribunal, taking a consistent view, we direct exclusion of these two companies from the final list of comparables.

Inclusion of comparables

Akshay Software Technologies Ltd.

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assessee as a comparable for the assessment year 2009-10. It is submitted that that there is no change in the facts pertaining to the company, and therefore Akshay ought to be included in the final list of comparables. Detailed submissions in this regard are placed at pages 358- 364 of the paperbook.

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comparable. We direct the TPO to include the said company as a comparable along with the two comparables, namely, M/s. R. S. Software (India) Ltd. and M/s. Thinksoft Global Services Ltd, and rework the mean PLI. ALP adjustment, if any, required shall be based on such mean PLI, after considering the working capital adjusted. Ordered accordingly. Ground 12 of the assessee is allowed.” 81. In view of the above decision of the Tribunal, the AO/TPO is directed to consider Akshay Software Technologies Ltd. as a comparable.

Technosoft Engineering

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to whether such services are in the nature of software development. Further, the assessee failed to substantiate that the company qualifies all the filters applied by the TPO. Accordingly, the rejection of the above company is to be upheld.

Textual information (14) Disclosure in auditors report relating to maintenance of cost records According to the information/explanations given to us and the books & records examined by us, since the company is carrying out of Computer Software designing activity and other allied services during the year therefore Maintenance of cost records Under Section 209(1)(d) of the Companies Act, 1956 is not applicable to the company. [100200] Statement of profit & loss Unless otherwise specified all monetary values are in INR 1.4.2011 to 1.4.2010 to 31.3.2012 31.3.2011 Statement of profit & loss (Abstract) Disclosure of revenue from operations (Abstract) Disclosure of revenue from operations for other than finance company (Abstract) Revenue from sale of products Revenue from sale of services 13,31,10,444 11,95,52,334.63 Other operating revenue 1,93,24,552 1,79,90,616 Total revenue from operations other than 15,24,34,996 13,75,42,950.63 finance company Total revenue from operations 15,24,34,996 13,75,42,950.63 85. However, the allegation of the ld. DR is that the complete financials are not made available to the AO/TPO. In our opinion, if the data is not in the public domain, the AO can exercise his powers u/s. 133(6) of the Act to obtain the financials of this company and decide the issue accordingly. Hence this issue is remitted to the AO/TPO.

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Evoke Technologies Ltd.

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therefore submitted that the company ought to be included in the final list of comparables.

• Oracle Consulting Service • Microsoft Consulting Services • Java Consulting Services • IT Staffing Solutions • QA and Testing Services • Mobility Services • BPM Consulting Services • Open Source Services • Big Data & Analytics Solutions 90. The above functions are not comparable to the software development services rendered by the assessee and therefore the rejection of the above company from the comparables is to be upheld.

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Corporate Tax issues

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products to the customers. The Appellant creates two kinds of provision for warranty, they are:

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

b. Additional provision for warranty – Bearing in mind the nature of industry of that of automobile components manufacturer, the assessee needs to create additional provision for warranty based on the circumstances and specific cases. During the year under consideration, additional provision for warranty amounting to Rs. 7,07,03,390/- was created for sales made to Tata, Mondo (Glovis) and Ford. The defects that occurred in sales to each customer is as follows:- Customer Name Defect Tata The LED lights are not working Mondo (Glovis) There is a flux issue in the Electronic Controller Unit for steering Ford Cracks found on the top crystal on the visible radius

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Particulars General Specific Total Warranty Warranty Opening balance 1,39,86,741 3,02,01,581 4,41,88,322 Provision created 76,64,521 7,07,03,390 7,83,67,911 Provision utilized against - - (2,62,34,907) actual payment/debit by customer Closing balance - - 9,63,21,326

a) The quality department of the company maintains the record/data for goods returned from the customers for the purpose of warranty claims.

b) The compilation would have details relating to each product for which warranty has been claimed and the month in which such products are manufactured.

c) Based on this data, the company would arrive at a percentage of warranty that needs to be created for each product.

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considers the sale for the past 24 months and the goods returned for the purpose of warranty claims during that period. Based on these actual data, percentage of likely warranty claim is arrived at. This percentage is applied for the purpose of creating provision against sales of each month. Thus after following the said method, the company has created the provision for general warranty. The summary of the provision for warranty is available at pages 2294-2409 of the paperbook.

• 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); • Hewlett Packard India Sales (P.) Ltd. v CIT[2014] 49 taxmann.com 166 (Karnataka High Court);

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• 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). 103. Based on the above discussion, the ld. AR submitted that the expenses incurred by it towards warranty expense are allowable under section 37 of the Act. 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. Also, it is submitted that for the assessment years 2008-09 and 2011-12 the issue has been remanded for fresh consideration by this Tribunal.

"we peruse paragraph 9 of the draft assessment order, from which, it is noticed by us that the A.O. made the disallowance on the reason that the assessee failed to furnish the scientific basis on which the provision is made. It is also noticed by us from the order of the DRP for A.Y. 2010- 11, that the actual expenses incurred during the year was Rs. 1,95,00,000/- as against the provision for warranty of Rs. 87,38,000/- was made. It is also noticed by us from the order of the DRP for A.Y. 2009-10, that the DRP has given the contradictory finding, in one side the DRP directed to allow the claim of provision of warranty of Rs.1,09,46,000/- and on another side, directed that Rs.98,67,981/- being the actual claim of warranty should be allowed" It is also evident from the orders of the DRP for A.Y. 2009-10 that the difference in the actual expenditure and the provision was marginal, whereas, in 2010-11, the actual expense incurred was more than the provision made. In the year under consideration, the actual expense is Rs.1,66,77,339/- whereas, the provision for warranty made during the year is Rs.5,28,64,672/-. These facts

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makes us clear that no scientific method was followed for making the provision for warranty and in such circumstances, the judicial pronouncements on which the reliance has been placed by the assessee including the decisions of the DRP, are not of any help to the assessee. In such circumstances, we are of the view that A.O. was justified in allowing the actual expenses of Rs.1,66,77,339/-, the above objections are accordingly rejected." 105. She submitted that the above finding of the DRP for the AY 2011- 2012 makes it clear that the assessee was not following a scientific method. The fact narrated by the AO in the draft assessment order for the assessment year, at para-8, that the provision is not based on a scientific method and therefore the decision of the Hon'ble Supreme Court, on which reliance has been placed, is not applicable. The movement in provision for warranty account as under also makes it clear that the warrant provision is not made on a scientific basis:

Amount in INR General Specific Particulars Total Warranty Warranty Opening balance 13,986,741 30,201,581 44,188,322 Odd: Provision created during the year (debited 7,664,521 70,703,390 78,367,911 to P & L A/c) Less : Actual warranty claims - - (26,234,907) Closing balance 96,321,326

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“16. The question which arose for determination was : whether during the assessment years 1949-50, 1950-51, 1951-52 and 1952-53 the assessee-company was entitled to claim deduction of the yearly premium from its profits under section 10(2)(xv) of the Income-tax Act, 1922. It was held that the provision in the policy for surrendering annuity and the provision in policy for return of premium was not entitled to deduction as the payment made to the trustees by the assessee-company was towards a contingent liability or towards a liability depending on a contingency, namely, the life of a human-being. It was held that putting aside of money which may become expenditure on the happening of an event is not an expenditure under section 10(2)(xv) of the 1922 Act. It was held on facts that the money was placed in the hands of trustees and/or the insurance company to purchase annuities, if required, but to be returned if the annuities were not purchased. Therefore, it was a case of setting apart of the money and consequently the assessee was not entitled to deduction under the said section. 17. At this stage, we once again reiterate that a liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate is possible of the amount of obligation. As stated above, the case of Indian Molasses Co. (P.) Ltd. (supra) is different from the present case. As stated above, in the present case we are concerned with an army of items of sophisticated (specialised) goods manufactured and sold by the assessee whereas the case of Indian Molasses Co. Ltd. (supra) was restricted to an individual retiree. On the other hand, the case of Metal Box Co. of India Ltd. (supra) pertained to an army of employees who were due to retire in future. In that case the company had estimated its liability under two gratuity schemes and the amount of liability was deducted from the gross receipts in the profit and loss account. The company had worked out its estimated liability on actuarial valuation. It had made provision

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for such liability spread over to a number of years. In such a case it was held by this Court that the provision made by the assessee- company for meeting the liability incurred by it under the gratuity scheme would be entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The same principle is laid down in the judgment of this Court in the case of Bharat Earth Movers (supra). In that case the assessee-company had formulated leave encashment scheme. It was held, following the judgment in Metal Box Co. of India Ltd.'s case (supra), that the provision made by the assessee for meeting the liability incurred under leave encashment scheme proportionate with the entitlement earned by the employees, was entitled to deduction out of gross receipts for the accounting year during which the provision is made for that liability. The principle which emerges from these decisions is that if the historical trend indicates that large number of sophisticated goods were being manufactured in the past and in the past if the facts established show that defects existed in some of the items manufactured and sold then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deduction from the gross receipts under section 37 of the 1961 Act. It would all depend on the data systematically maintained by the assessee. It may be noted that in all the impugned judgments before us the assessee(s) has succeeded except in the case of Civil Appeal Nos. 3506-3524 of 2009 - Arising out of S.L.P.(C) Nos. 14178-14182 of 2007 - Rotork Controls India (P.) Ltd. v. CIT, in which the Madras High Court has overruled the decision of the Tribunal allowing deduction under section 37 of the 1961 Act. However, the High Court has failed to notice the "reversal" which constituted part of the data systematically maintained by the assessee over last decade. 18. For the above reasons, we set aside the impugned judgment of the Madras High Court dated 5-2-2007 - Rotork Controls India (P.) Ltd.'s case (supra) and accordingly the civil appeals stand allowed in favour of the assessee with no order as to costs.” 108. In view of the above judgment, we direct the AO to examine the assessee’s past record and allow the provision for warranty in the same proportion as compared to the sales as in the earlier assessment years.

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For this purpose, the AO may consider the data of the immediate past five assessment years and decide the issue accordingly.

Sl. Nature of expenses Amount in No. INR 1 License fees to group companies 26,39,28,539 2 Payment of R & D Cess 2,83,62,813 3 Third party and others (7,86,669) Total 29,15,04,683

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Expenditure incurred is allowable under section 37 of the Act:

a. Annual License Fee:

Agreement A (page no. 1125 to page no. 1137 of the paper book) The assessee has entered into a License Agreement effective from 1st 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 Appellant for development, manufacturing and sale of automotive products. • Compensation for the aforementioned license has been agreed to be paid by the Appellant 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 no. 2241 to page no. 2251 of the paper book): The Appellant has entered into a License and Technical Assistance Agreement effective from 1st January 2009 with Continental Teves AG & Co. OHG, Germany ("CT AG").

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• Under this agreement, CT AG grants license to use technical information for development, manufacture and sale of sensors. • Compensation for the aforementioned license has been agreed to be paid by the Appellant as an annual royalty fees of 6% of net sales of sensoric products per year

Claim of annual license fees as revenue expenditure under section 37(1)

i. Section 37 of the Act is a residual clause for claiming deduction for any expenditure incurred for the purposes of the business. ii. For the purpose of claiming deduction under section 37 of the Act, the following conditions should be fulfilled: • The expenditure must be revenue in nature and should not be covered by any express deductions under sections 30 to 36 of the Act. • The expenditure should not be personal in nature. • The expenditure should be incurred wholly and exclusively for the purposes of the business or profession. iii. The annual license fee is payable for making use of licensed intellectual property and/ or technical information owned by the Continental Group.

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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 Appellant for increasing profitability relating to products manufactured by the Appellant 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 Appellant. 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 Appellant in this regard. Accordingly the same should be considered as revenue in nature and should be allowed as deduction under section 37(1) of the Act, since it satisfies all the aforementioned conditions. viii. In this regard, reliance is placed on following decisions: • Kanpur Cigarettes (P.) Ltd. v. CIT147 Taxman 428 (Allahabad High Court) • CIT v. Kirloskar Tractors Ltd [1998] 231 ITR 849 (Bombay HC) • Alembic Chemical Works Co. Ltd. v. CIT[1989] 43 Taxman 312 (SC) • J.K. Synthetics Ltd. v. CIT[2009] 176 Taxman 355 (Delhi High Court) • DCIT v. Honda SIEL Power Products Ltd I.T.A .No. 1579/DEL/2017 (A.Y 2012-13) & S. A No. 217/Del/2017 in ITA No. 1579/Del/2017 ix. Based on above judicial decisions, the factors to be considered and conditions to be satisfied are summarized below:- Factors to be Conditions to be satisfied considered License period The license is granted for a limited period and not and termination exclusive. The parties have a right to terminate the license Restriction on The licensee has restricted rights to create further rights/ creation of assign the license in favor of third parties

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further rights/ assignment Confidentiality The arrangement prohibits parting with confidential information Degree of The license does not transfer all the ‘fruits of research’ of transfer the licensor, “once for all” Nature of royalty Royalty paid as a percentage of sales is linked to sales achieved by the assessee and hence, is considered as cost in earning the same 115. He submitted that in the case of the assessee, the agreements under which the annual license fees was paid, satisfies the aforementioned conditions as under:-

Factors under Whether the conditions are Clause reference in the consideration satisfied? Agreements A and B • License period Yes. Both the licenses are Agreement A - and termination granted for a limited period. 6.1.2 • The agreements can be Agreement B - 7.1 terminated at the discretion of and 7.2 both parties. • Restriction on Yes. The Appellant can sub- Agreement A - 2.2 • creation of license only on receipt of prior Agreement B - 3.1 further rights/ written approval from the assignment Licensor. • Confidentiality Yes. The Appellant is Agreement A - 8 • obligated to hold in confidence Agreement B - 6.1 all the information provided to 6.5 under 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 royalty Yes. Royalty was paid based Agreement A - 5.1 • on a percentage of net sales as Agreement B - 4.1 provided in the agreements

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Standard Practices:

a) Continental global provides access to standard procedures, methodologies, best practices, knowledge updates, etc. relating to manufacturing process of a product. These are provided largely through software platforms used by Continental group 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 Appellant 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 Appellant 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.

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d) Corporate Project Management Manuals and Standards – CPMMs and CPMS provided by Continental global aid in project management. Further, the Appellant refers 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 Appellant to upgrade its business including the manufacturing process to the latest available technology.

- Access to various tools/platforms

a) There are numerous tools/ software platforms that are made available by Continental global to the Appellant 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 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.

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- 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, camline etc. are provided to the Appellant and some of the key tools in use by the Appellant are discussed below:-

Sl. Tool Name Tool/ platform Benefit to description No. ‘Continental India’ 1 Tech.Net It is a platform which Appellant uses Tech.net provides access to (manufacturing latest technical technology network) to information, standard gain access to the practices, procedures, technical information, etc. standard practices and documents, and applies/ implements the same for Tech.Net members its manufacturing process, possess highest level testing process, etc. of education (PHd) As mentioned earlier, this and provide support information and support is centrally to each a catalyst for the location whenever a Appellant’s business. problem cannot be resolved locally.

2 Collaborative Cobotis an advanced Cobothelps the Appellant robots version of robots in reducing dependency (“Cobot”) which focuses on on man power, suppliers safety and cost of raw material. This reduction. This is enhances overall easy and simple to performance with possible program as per the savings in terms of lead user requirement. time and increase in efficiencies. 3 Camline Camline is an Camline analyses internal customized performance of the software for machineries over a period monitoring and and provides quality rates, tracking of the line performance rates. It also performance of the records the equipment

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machinery/ status and provides report equipment in the of the unplanned errors plant during the occurred. process of manufacturing. 4 Space LFPT tool is another This helps the Appellant planning tool tailor-made tool from in planning as well as Continental global optimum utilization of for management of available resources. manufacturing floor space, logistics floor space etc. 5 Manufacturing MES is an auxiliary MES is integrated with the execution bundle of software SAP system in a way that systems that work hand-in- MES provides automatic (“MES”) hand with Camline data to SAP. It counts software/ platform automatically how many and provides real units were built, how time production many tests failed, how monitoring. many units were shipped, what product routing (recipe) 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).

Snapshots depicting the working of the tools and reports generated are produced before this Tribunal under cover of an application for additional evidence.

- Assistance in sourcing:

a) Continental global has a global strategic sourcing approach i.e. strategy for obtaining raw material/ resources across the world in a

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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 Appellant 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.

- Provision of designs, procedures and layouts

Every product that the Appellant manufactures is unique and complex. Continental global develops and shares its designs, layouts and drawings relating to products, manufacturing process, etc. with the Appellant. 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 Appellant 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

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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.

- Testing

a) A crucial aspect of any manufacturing process is testing. The Appellant 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 Appellant 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 appellant requests the assistance of Continental global. A screenshot of the source code shared with the Appellant 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

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action points for the Appellant. Sample email communications are also part of the application for additional evidence.

- Problem resolution

a) The Appellant seeks the help of Continental global to resolve issues in cases where the Appellant is unable to do so. Continental global provides the appellant 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.

- Other assistance:

a) Continental global enters into centralized agreements for procuring certain techniques, technical services. This helps the Appellant to improve the product quality. The aforesaid assistance received from Continental group helps in improving the technological performance of the Appellant’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 Appellant and ensures access to latest technical information.

The assessee has filed an application for additional evidence to produce snapshots of various manuals, processes, standard documents and email communications demonstrating the rendering of services under each of the heads specified above. Based on the above, it was submitted that as the

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present case satisfies the conditions of section 37 of the Act, the license fee paid should be allowed as revenue expenditure.

b. R&DCess:

Sl. Learned AO’s Appellant’s submission No. contention 1 No proper evidences The Appellant had submitted the following furnished details to the learned AO: 1. Ledger extracts of R&D expense 2. Sample invoice copies raised on Appellant by group entities 3. Copy of agreements entered into with group entities 4. List of projects for which amount was 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 Appellant. 2 Reasons for Appellant had submitted that R&D is only a classification of nomenclature used by the Appellant in the expense as R&D not financial statements and a major portion of provided the said expense is towards annual license fees paid by the Appellant to its group companies. 3 Expense is capital in From the above factual and legal basis, the nature since it provides Appellant submits that the impugned expense enduring benefits is not a capital expenditure, as there is no enduring benefit derived by the Appellant. The same is related to the business of the Appellant. 4 No rationale for The Appellant submits that merely because

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entering into agreement an agreement is entered into, no businessman with its group entities would change the business. It is for the since the Appellant was purpose of the business that a businessman carrying on the enters into an agreement. business even prior to entering aforesaid Appellant had taken a business decision to agreements avail the services from group entities to facilitate and further its business objects. It is also submitted that having provided the factual and legal basis of the expense, the learned AO cannot question commercial expediency of a transaction. Further, entering into agreements for use of intellectual property of the group companies has benefited the Appellant. 5 Sundry creditors are This is a mere remark made by the learned increasing AO without any basis/ conclusion towards the same. However, the Appellant submits that sundry creditors account is a running account and represents payables to third parties/ group entities for goods/ services availed from them. 6 Evidence for The Appellant submits that it has duly deducting the taxes at deducted tax at source under Section 195 of source not furnished the Act, on the payments made/payable to the group companies. 7 No rationale for paying The import of raw material, consumable and royalty since there are other supplies from the group companies and import of raw payment of royalty are two distinct materials, transactions, and the Appellant has consumables, and other substantiated the business rationale for the supplies. 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 Appellant. 119. Based on the above, the ld. AR submitted that the impugned expense is revenue in nature and the same is allowable under section 37 of the Act. Without prejudice to the above, it is submitted that for the

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assessment years, i.e., 2009-10 and 2011-12, the similar issue has been remanded for fresh consideration by this Tribunal.

Claim of the Appellant under section 35(1)(iv) of the Act

Claim of the Appellant under section 32 of the Act

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"we peruse the draft assessment order from which it is noticed by us that the A.O. in paragraph 10.3 has observed that the assessee has not produced necessary approval from the prescribed authority i.e. secretary , Department of Scientific and Industrial Research. It is also stated that no such approval have been produced nor any evidence has been produced in respect of nature of expenses. The A.O. also observed that the R&D activities carried out while result in enduring benefit to the assessee. It is also noticed by us from paragraph 10.2 of the draft assessment order that before the assessing officer, the evidences now has been produced before us have not been made available to arrive at a correct conclusion. It is also noticed by us that the similar issue was examined by the DRP in A.Y. 2009-10 and 2010-11. The observation of the DRP-1, Bengaluru for A.Y. 2010-11 as narrated in paragraph 4.3 of the order are reproduced below :- "Having heard the assessee and examination of the finding recorded by the Assessing Officer, we examined the records and submissions made by the assessee, the outcome of which is summarized below :- (i) In the profit and loss account, the amount has been debited under the head 'Research & Development' , there is nothing on record to suggest that before the Assessing Officer, the alleged license agreement between the assessee and Continental Automotive GMBH, Germany dated 01-01-2009 (hereafter referred as Agreement) was produced, which is further evident from the submission of the assessee reproduced by the Assessing Officer. The assessee is carrying out similar business prior to 01-01- 2009, hence, we do not find any rationale for entering into agreement with the AE w.e.f. 01-01-2009. (ii) As per the Agreement, the amount claimed is Royalty and therefore, we do not find any rationale in debiting such amount in profit and loss account as R&D expenses. (iii) On perusal of the balance sheet, it is also noticed by us that the sundry creditor in respect of Continental Automotive GMBH, Germany is increasing on year to year basis.

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(iv) On perusal of the audit report in Form 3CD, it is noticed by us that in respect of particulars of payment made to the specified persons u/s 40A(2)(b) of the Income tax Act, the amount of 10,88,25,803/- has been mentioned as payment for Research and Development/ (v) If we go by the Agreement, the amount is in the nature of Royalty paid to a non-resident hence, liable for deduction of tax at source u/s 195 of the Income tax Act. However, there is no evidence to support that the tax has been deducted at source on payment of such Royalty. (vi) In the TP study, the above amounts has not been shown separately as payment of Royalty, similarly, in audit report in Form 3CEB also, the amount has not been shown as paid towards Royalty. (vii) Except the copy of the agreement, the assessee failed to produce any evidence to support the technical knowhow provided by the AE, further, when the import of raw material, consumable and other supplies are from the AE, there is no rationale for making the payment of above Royalty on sales, In addition to the payment of capital expenditure on technical knowhow amounting to 45.41 crores to the AE during the year. In view of the fact discussed as above, we are of the view that the above payment of Royalty is not a genuine expenditure which can be allowed u/s 37(1) or under any other provisions of the Income tax Act. Accordingly, the objection is not found acceptable. The fact and circumstances are similar for the assessment year also. Further, it is a case where the similar disallowance is made from A.Y. 2009-10 and confirmed by DRPs, but the evidences in the form of so called agreement or any other evidence was never produced before the A.O., even though specifically asked for and therefore, we are not inclined to admit and examine such evidences produced before us at this stage, accordingly, the above objections are dismissed." 125. The ld. DR submitted that the factual aspect of the above claim remains the same with one more addition of fact that during the

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assessment year, the assessee also failed to produce such evidences before the TPO during the TP proceedings and therefore the TPO considered the ALP of such transactions at 'nil'. In respect such payments to the extent of Rs.26,39,28,539, the findings recorded by the TPO and the Assessing Officer, both makes it clear that the expense of Rs.26,39,28,539 are not genuine and therefore not allowable under section 37(1) of the Act, question of allowing such claim under section 35(1) does not arise. At the same time, the DRP disagreed with the finding of the Assessing Officer that the said amount is a capital expenditure and hence was of the view that the question of allowing depreciation under section 32(1) does not arise. In respect of the balance amount of Rs.2,75,76,144 (29,15,04,683 - 226,39,28,539) also, the assessee failed to furnish evidences before the Assessing Officer to establish that the services are actually rendered and therefore such expenses cannot be allowed under section 37(1) of the Act.

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37(1) and alternatively under section 40(a)(i) has to be revived as the assessee failed to produce any evidence to establish that tax was deducted at source and paid within the time limit allowed under proviso applicable to sub-clause (i) of clause (a) of section 40 the Act for the assessment year. Accordingly, the DRP directed the Assessing Officer to reduce the proposed addition by Rs.26,39,28,539.

“7. Ground No.2 (a to h) - Annual Licence Fees / R & D Expenses 7.1 In the course of assessment proceedings, the AO noticed that the assessee had debited an amount of Rs.22,39,43,000/- towards R & D Expenses. The AO observed that the assessee had not furnished any evidence of the nature of expenses and therefore held them to be capital in nature and disallowed the assessee's claim. The AO also observed that approvals from prescribed authority were also not furnished. The DRP, while disposing off the assessee's objections, confirmed the action of the AO in disallowing the expense by stating that the evidences now produced before the DRP have not been made available to the AO to arrive at a correct conclusion. The DRP also noted that similar issue was examined by the DRP in Assessment Year 2009-10 and held that where similar disallowance was made for Assessment Year 2009-10 was upheld by the DRP. However, since the evidences were never produced before the AO, the DRP in this year i.e., Assessment Year 2011- 12 declined admission of the evidence produced by the assessee and upheld the addition. 7.2.1 We have considered the rival contentions of both parties and perused and examined the material on record in respect of the issue of R & D IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 expenses; which is for consideration before us. The assessee has debited these expenses in the Profit & Loss

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Account under the head "R & D Expenses". However, in its objections before the DRP, the assessee claimed that these expenses are towards annual licence fee for the R & D work carried out by the group company, which was used by the assessee. This claim, though not put forth before the AO has been made before the DRP. The DRP, however, declined admission of this claim and also the details / documents filed in support thereof. In doing so, the DRP has relied upon the decision of the DRP for Assessment Year 2009-10. 7.2.2 We find that the Co-ordinate Bench of this Tribunal in its order in IT(TP)A No.165 and 254/Bang/2014 dated 28.09.2017 in the assessee's own case for Assessment Year 2009-10 had remanded this issue back to the file of the AO for fresh examination and adjudication. The grounds raised by the assessee in this regard before the Tribunal for Assessment Year 2009-10 at 8 to 8B at page 3 of the order of the Co-ordinate Bench are extracted hereunder: "8. Disallowance of Research and Development (R&D) Expenditure-- Rs. 33,897,837 8.A The learned AO erred in concluding approval under section 35(2AB) is mandatory for claiming expenses in the nature of annual license fee, testing charges and engineering services charges which have been merely grouped as R&D Expenditure. The learned AO ought to have appreciated that these expenditure are towards operating activities of the Appellant and do not provide any enduring benefits. 8.B Notwithstanding and without prejudice to the above, even if the said expenditure are held to give enduring benefit on the argument that the same pertain to research & development, the expenditure should be allowed as a deduction under section 35(1) of the Act." 7.2.3 The Co-ordinate Bench of the Tribunal in its order for Assessment Year 2009-10 (supra) disposed off this ground of appeal at paras 6 & 7 of the order; which is extracted hereunder:- "6. Regarding corporate tax issues raised by the assessee in its appeal as per ground nos. 8 and 9, it was submitted

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by ld. AR of assessee that ground no. 9 is not pressed and accordingly ground no. 9 is rejected as not pressed. Regarding ground no. 8, it was submitted that the finding of DRP on this issue is in para no. 18 of DRP order wherein it is noted by DRP that the onus lies on the assessee to prove that the expenses was laid out exclusively for the business and that it wasn't in the nature of capital expenditure to claim it u/s.37(1) but in the present case, the assessee has not been able to substantiate its claim either way. It is also noted by DRP that before the AO, the assessee could not establish that the expenses was on Research & Development activities. He submitted that this matter may also be restored back to the file of AO for fresh decision and if that is done then the assessee will provide all the details required by the AO for this purpose. The ld. DR of revenue supported the orders of authorities below. 7. We have considered the rival submissions. Regarding ground no. 8 of assessee's appeal, we feel it proper that this issue should go back to the file of AO for fresh decision and hence, we restore this matter back to the file of AO for fresh decision with the direction that the assessee should provide complete details and evidence which may be required by the AO to examine and decide the claim of the assessee. The AO should provide reasonable opportunity of being heard to assessee. Ground no. 8 is allowed for statistical purposes." 7.2.4 In view of the above order of the Co-ordinate Bench of this Tribunal in the assessee's own case for Assessment year 2009-10 (supra), and considering that the claim of the assessee regarding the expenses being for annual licence fees has not been examined at all and that the details / evidences submitted by the assessee before the DRP has not been admitted for consideration, we deem it appropriate to follow the order of the Co-ordinate Bench of this Tribunal in the assessee's own case for Assessment Year 2009-10 (supra); admit the details filed by assessee before DRP and remand this issue back to the file of the AO with the same directions as contained in the Tribunal order for Assessment Year 2009-10 (supra). The assessee is directed to provide complete details and evidence of its claim which may be required by the AO to examine and decide the matter. Needless to add, the AO

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shall provide adequate opportunity of being heard to the assessee and to duly consider the submissions, details and evidences put forth by the assessee before deciding the issue. Consequently, ground 2 (a to h) is treated as allowed for statistical purposes.” 128. Being so, we remit this issue to the file of AO with similar directions as per the above order of the Tribunal in assessee’s own case.

Pronounced in the open court on this 24th day of November, 2021.

Sd/- Sd/-

( N V VASUDEVAN ) ( CHANDRA POOJARI ) VICE PRESIDENT ACCOUNTANT MEMBER

Bangalore, Dated, the 24th November, 2021.

/Desai S Murthy /

Copy to:

Assistant Registrar ITAT, Bangalore.