MARATHON ELECTRIC INDIA (P) LTD.,FARIDABAD vs. ADDL. CIT, NEW DELHI

ORDER PER O.P. KANT, AM:

These appeals are directed against separate final assessment orders dated 23.09.2011 and 21.01.2014, passed by the learned Addl. Commissioner of Income Tax, Range-1, Faridabad, and Deputy Commissioner of Income Tax, Circle-1, Faridabad, for assessment year 2007-08 and 2009-10 respectively, pursuant to the direction(s) of the learned Dispute Resolution Panel (in short ‘DRP’). As identical issue are involved permeating from the same set of facts, we have heard both the appeals together and disposed off by way of this consolidated order for the sake of convenience.

Assessment Year : 2007-08 2. First we take up the appeal bearing for assessment year 2007-08. The Grounds of appeal for assessment year 2007-08 are reproduced as under:

1. That the learned Assessing Officer (‘AO’) erred in passing the impugned draft assessment order dated November 30, 2010 (‘the Draft Assessment order’) and the Hon’ble Dispute Resolution Panel (‘Hon’ble DRP’) erred in passing directions under Section 144(C) of the Income Tax Act, 1961 (‘the Act’) confirming the Draft Assessment order. On the facts and circumstances of the case and in law, the learned AO erred in assessing the income of the Appellant at Rs.342,239,410 as against the returned income of Rs.162,653,930.

2. On the facts and in the circumstances of the case and in law, the Hon’ble DRP has erred in not considering the submissions filed by the Appellant and passed a very laconic and non-speaking order confirming the Draft Assessment order.

3. On the facts and in the circumstances of the case and in law, the learned AO erred in proposing and the Hon’ble DRP further erred in confirming the action of learned AO of disallowing the Appellant’s claim of deduction under section 10B of the Act amounting to Rs. 154,143,267 in respect of its newly established hundred percent Export Oriented Unit (‘EOU’) despite the fact that the Appellant satisfied with all the conditions laid down under section 10B of the Act.

4. On the facts and in the circumstances of the case and inn law, the learned AO erred in proposing and the Hon’ble DRP further erred in confirming the action of learned AO in relying upon irrelevant material and consideration and ignoring relevant facts while erroneously concluding that the new unit was not “a newly established independent and integrated undertaking”, which could be eligible for benefit under section 10B of the Act.

5. On the facts and in the circumstances of the case and in law, the learned AO erred in proposing and the Hon’ble DRP further erred in confirming the action of learned AO by rejecting the Appellant’s claim of the deduction under Section 10B of the Act ignoring the factual position that the new unit is a 100 percent EOU duly approved by the prescribed authorities.

6. On the facts and in the circumstances of the case and in law, the learned AO erred in proposing and the Hon’ble DRP further erred in observing that the Appellant’s case was a case of reconstruction of the business already in existence and that there was no emergence of a new physically separate industrial unit, despite all the relevant facts placed on record by the Appellant.

7. On the facts and in the circumstances of the case and in law, the learned AO as well as Hon’ble DRP erred in not following the order passed by Hon’ble Commissioner (Appeals) [Hon’ble CIT(A)’] for previous assessment years (‘AY’) i.e. AY 2003-04 to AY 2006- 07, wherein Hon’ble CIT(A) has upheld the Appellant’s claim of deduction under Section 10B of the Act.

8. Without prejudice to the Appellant’s contention, On the facts and in the circumstances of the case and in law, the learned AO as well as Hon’ble DRP, while rejecting the Appellant’s claim of deduction under Section 10B of the Act for the subject year, failed to appreciate that the conditions required to claim the deduction under Section 10B of the Act are required to be satisfied in the year of formation of the eligible unit and not in subsequent years.

9. On the facts and circumstances of the case, the Learned (‘Ld.’) Assessing Officer (‘AO’) / Transfer Pricing Officer (‘TPO’) have erred in determining the arm’s length price of the international transaction of the Appellant for payment of testing, warranty repair and service charges fee to its AE to be NIL, thereby making an addition to the total income of Rs. 2,54,42,211/- on account of transfer pricing.

10. That the Ld. AO / TPO failed to appreciate the characterisation of the entities involved in the transaction and that the conduct of the Appellant confirms to the allocation of risk i.e. the entity bearing product liability risk is undertaking decisions in relation to the same.

12. That the Ld. AO / TPO have erred by questioning the commercial/business wisdom of the Appellant for undertaking the transaction of testing, warranty repair and service charges fee, which is imperative to Appellant’s business.

13. That the Ld. AO / TPO have failed to appreciate the fact that no benefit has been passed on to the AE by payment of testing, warranty repair and service charges as the AE is recovering exactly the same amount as has been paid by them to independent third party for availing such services.

That the above grounds of appeal are independent and without prejudice to each other.

That the appellant reserves its right to add, alter, amend or withdraw any ground of appeal either before or at the time of hearing of this appeal.

3. Briefly stated facts of the case are that, the assessee filed return of income on 25.10.2017, declaring income of Rs.16,27,03,930/-. The case was selected for scrutiny and notice under section 143(2) of the Income-tax Act, 1961 (in short ‘the Act’) was issued and complied with. During the assessment proceedings, the Assessing Officer noted that the assessee company deals in manufacturing of ‘Fractional Horse Power’ (FHP) Motors, ‘Electric Fans’ & ‘Laminations’ used in motors. Besides, assessee-company is also engaged in trading of pumps and integral horse power motors and export of computer software. The company was registered with the Software Technology Parks of India w.e.f. 10.06.2005 and manufacturing activity commenced w.e.f. 01.08.2005 from the undertaking located at Laxmi Towers, Nagarjuna Hills, Hyderabad. The assessee had claimed deduction of Rs. 1,20,01,770/- under Section 10B of the Act for the first time from the assessment year 2006-07. The assessee carried out manufacturing functions from facility situated at Faridabad through two plants- an Export Oriented Unit (“EOU”) and Domestic Tariff Area (“DTA”) Unit. In the case of the assessee, the Assessing Officer also observed that international transaction of testing and warranty service charges paid to Associated Enterprises (AEs), namely, M/s. Regal Belait Electric Motors Inc., USA, amounting to Rs.2,54,42,211/-. The Assessing Officer referred the benchmarking of the international transaction to the learned Transfer Pricing Officer (in short ‘TPO’). The learned TPO computed the Arm’s Length Price at nil and accordingly, he proposed adjustment of Rs.2,54,42,211/- vide his order dated 06.08.2010. The learned Assessing Officer in the proposed draft assessment order made addition of transfer pricing adjustment of Rs.2,54,42,211/-. The Assessing Officer also proposed disallowance of deduction under Section 10B of the Act, amounting to Rs.15,41,43,267/-. In this manner, the learned Assessing Officer proposed total addition of Rs.17,95,85,478/- in the Draft Assessment order dated 30.11.2020. Aggrieved, the assesse filed objection before the learned DRP, but could not succeed and the learned DRP upheld the additions proposed by the Assessing Officer in order dated 05.07.2011. Pursuant to the direction of the learned DRP, the Assessing Officer passed the impugned final assessment order on 23.09.2011 wherein following two additions have been made: 1. On account of TPO order in relation to Arm’s Length Price of International Transactions (as discussed above) Rs.2,54,42,211/- 2. On account of deduction u/s 10-B Rs.15,41,43,267/- (as discussed above) Total Rs.17,95,85,478/-

4. On the issue of disallowance of deduction under Section 10B of the Act, learned counsel submitted that in assessment year 2003-04 2006-07, the disallowance made by the Assessing Officer has been deleted by the Tribunal and, therefore, the issue in dispute being covered in favour of the assessee, the disallowance was required to be deleted in the instant year also. The learned counsel for the assessee submitted that the eligibility conditions of expansion of the existing Unit and product manufacture by the assessee were already examined in the first year of the claim of the deduction and, therefore, in view of the decision of the Hon’ble Delhi High court in the case of CIT Vs. Tata Communication Internet Services Ltd. (2012) 204 Taxman 606 (Del) deduction has to be allowed for entire period of 10 years, if the conditions have been fulfilled in the initial year.

4.1 On the contrary, learned DR relied on the order of the lower authorities. 4.2 We have heard the rival submissions of the parties and perused the relevant material on record. In the year under consideration, the Assessing Officer relying on the order of the immediately preceding year held that Export Oriented Unit (“EOU”) is just an expansion of the existing unit and not an integrated new unit. The learned DRP also upheld the same. We find that the Tribunal in and 1196/Del/2010 for assessment years 2005-06 and 2006-07 respectively, following the earlier order deleted the disallowance of deduction under Section 10B of the Act observing as under: “4. We have gone through the order dated 26.03.2019 passed in assessee’s own case for the AY’s 2003-04 and 2004-05 in the appeals preferred by the revenue, wherein in respect of the claim of deduction u/s 10B of the Act, a coordinate bench of this Tribunal found that by applying the decision of the Hon’ble Apex Court in the case of Textile Machinery Corporation Ltd. Vs. CIT, 107 ITR 195 (SC) learned CIT(A) had rightly extended the relief to the assessee u/s 10B of the Act and, therefore, the revenue cannot have any grievance against the same. It is not the case of the revenue that any appeal was preferred against the order or that this position was disturbed.

4.3 Since in the year under consideration, the Assessing Officer has followed the earlier years’ order, therefore, the issue in dispute being squarely covered by the decision of the Tribunal (supra), we delete the disallowance. The grounds of appeal of the assessee from ground nos. 1 to 8 are accordingly allowed.

5. Ground no. 9 to 13 of the appeal are related to the Transfer Pricing Adjustment. The learned counsel for the assessee referred to paper-books filed in two volumes from pages 1 to 715 and submitted that international transaction is in respect of ‘firewall charges’ reimbursement to AE. He submitted that when finished goods are shipped to the AE in US from Indian Ports, there is a time lag before the products reach the destined port. At times, motors capture moisture during the transit period and this can adversely impact their functioning. The moisture in the motor may cause sparking at the time of usage and can cause harm to the user. On the request of the assessee, the AE engages a third party that tests all the motors to ensure the desired quality standards of the US market. The learned counsel for the assessee further submitted that in order to determine whether all motors meet the desired quality standards, each motor needs to be tested individually. He submitted that such testing charges incurred are paid by assessee to the AE which the AE pays to the third party on cost-to-cost basis without any mark-up. He submitted that the third party, i.e., Commercial Warehouse & Cartage Inc. (“CWC”) USA undertakes functions of unpacking, testing and repacking of motors. He submitted that payment of firewall charges was made by the assessee to its AE was an integral part of the manufacturing function, the same was aggregated and benchmarked using the TNMM as the most appropriate method. The learned counsel submitted that the learned TPO rejected the arguments put-forth by the assessee stating the following reasons: a) An unrelated party would not make such a payment; b) If the AE wishies to test all the motors for its satisfaction, then it amounts to duplicative service and no separate payment is required to be made by the assessee. c) No unrelated party would make payment for testing of motors in which no fault is detected; d) No independent party would pay such testing charges when goods are covered by warranty; and 5.1 The learned TPO in view his observations, benchmarked the transaction applying CUP method and valued at nil.” 5.2 The learned counsel for the assessee submitted that the learned TPO/DRP has ignored the following points which are primary reasons for which the assessee is incurring such expenses:

“(i) Impact on the brand reputation: It is important to understand that the main reason behind incurring such expenses is to ensure that none of the motors are defective when sold to the customer in the overseas market. It is pertinent to note that the product liability risk, in a value chain, is that of a manufacturer. Since in the instant case. MEIPL is the manufacturing entity, any defect in the product will have a detrimental effect on the brand reputation of MEIPL. In case any defect is identified in the goods which are being sold in the US market, the reputation of MEIPL would be impacted and not that of the distributor as the distributor is earning a gross margin by just rendering distribution services. Adverse brand reputation would lead to drastic reduction in sales in subsequent years and hence the profitability of the Assessee. (ii) Penal charges: It is important to understand that US being the most developed country in the world has the most stringent laws against the damages caused by the use of faulty/ defective items. A company could even face trial for providing faulty products. In the instant case, if the motors supplied by MEIPL to the customer is used in a building and due to a short circuit in the motor (because of the moisture) it catches fire, then this could lead to huge product liability claims been initiated against the manufacturer i.e. MEIPL and not the distributor. The Assessee could also face trial for the same apart from huge damages claim which will impact the overall reputation/ functioning of the Assessee.

(iii) Cost to cost charges: An important point which must be considered while evaluating arm’s length nature of this transaction is that, on request of MEIPL, the AE appoints the third party that performs unpacking, testing and repacking of motors. The cost of such activities is borne by the AE which then recovers exactly the same from MEIPL i.e. without charging any mark-up. In other words, this is a cost to cost reimbursement and hence the AE has not benefitted anything from this arrangement. These motors ought to have been tested in US only and could not have happened in India (as testing is performed to check moisture in motors during transit). If testing was possible in India, MEIPL would have directly appointed the third party. In this case, since the AE is familiar with the US market, has appointed this third party for the purpose of testing. Back to back invoices have already been submitted by the Assessee to the Ld. TPO / Ld. DRP (on sample basis for AY 2007-08) (For back-to-back invoices please refer pg 611-693 of PBII).

(iv) Cost not related to AE: It is hereby stated that the AE is a distributor of goods which are manufactured by the Assessee. It has also been stated before the lower authorities that the AE retains only 10% of revenue and the balance is remitted back to the Assessee. Hence, the profit is that of the Assessee with limited returns to the AE - a gross margin of 10%. Under these circumstances it that the AE would not bear such expense of testing when it is earning only minimal returns. Should the AE start to bear these expenses it’s margins would take a hit. In any third party set-up such costs can never be passed onto the distributor.”

5.3 Further, the learned counsel also submitted that why such testing was required and how it was different from warranty and other expenses, which are as follows: “11. The Ld. TPO has compared this expense with warranty' expenses. It is true that Assessee provides warranty, but this expense is separate and distinct to firewall charges. Any motor that does not contain moisture may also have functional problems (i.e. other problem relating to functionality of the motor) because of which MEIPL could bear the warranty charges. But it is the responsibility of the Assessee to provide the motors in working conditions. It is also important to point out that if products are sold without testing, it can lead to extra claims on warranty - which not only is economically non-viable but also impacts reputation of the company’s brand.

5.4 The learned counsel for the assessee also argued that this was a genuine business expenditure, incurred wholly and solely for the purpose of the business of the assessee and cannot be disallowed by the learned TPO. He submitted that the AE is merely acting as a distributor who is never liable for the goods manufactured. On the issue of application of the CUP method by the learned TPO, the learned counsel for the assessee submitted as under: “16. The learned TPO has further rejected the aggregation approach and benchmarked the transaction using CUP method. In this regard, the Assessee submits that subject transaction is interlinked with the primary transaction and the reason for the same is already mentioned in the TP study. However, without prejudice to the above, even if the approach of the Ld. TPO is to be selected, the Assessee furnished third party invoices which represented CUP for the subject transaction. However, the Ld. TPO ignored the same and determined the value to be ‘Nil’ without identifying a single comparable. In relation to the same, the Assessee wishes to rely on the following judicial rulings, wherein it has been held that it is imperative to have a Comparable uncontrolled transaction.

“8. From the above, it is obvious that for selecting a Comparable Uncontrolled Price method, the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transaction is to be identified. In this case, admittedly, no such companies were identified by the TPO or DRP. Therefore, this Tribunal is of the considered opinion that the matter needs to be reconsidered by the authorities below. ”

18, In the case of SNF (India) Pvt. Ltd. (ITA No. 279 & 280/VIZ/2017) (refer para 15, page 22 & 23 of the ruling; to be handed over by the counsel) wherein it was held that:

“15. During the appeal hearing, the Id.AR argued that the payment of royalty is interlinked with the manufacturing activity and other trading transitions, therefore, the TNMM is most appropriate method at the entity level and it is necessary to aggregate the entire transactions without delinking with the royalty payments. The Department could not establish that the royalty is independent and separate transaction for unbundling the royalty from the other transactions to determine the ALP independently. Once it is accepted that the technical support is required for manufacturing the product and it is interrelated the payment of royalty cannot be segregated and the transactions required to be aggregated at the entity level and the ALP required to be determined on the whole transactions. Though the TPO held that the CUP is most appropriate method for determining the transfer pricing of the royalty but did not bring any comparables for determination of the royalty payment………………..

………………..In the instant case assessee has not availed similar technology from any other third party and the associated enterprise has not provided the technology to any other third party. The Ld. TPO has not brought any comparable cases under CUP method for determination of ALP. Therefore taking in to consideration the entire facts and the materials placed before us we, agree with the Ld.CIT(A) that the TNMM is most appropriate method to determine the ALP at entity level. ”

5.5 The learned counsel further submitted that the issue in disputed in the case of the assessee was covered by the decision of the Hon’ble Jurisdictional High Court in the case of EKL Appliances Ltd. (ITA No.1068/2011 & wherein the Hon’ble Court has held that the assessee is not required to demonstrate that the expenditure has actually resulted in profit or income either in the same year or in any of the subsequent year. The only condition is that the expenditure should have been incurred “wholly and exclusively” for the purpose of business. The relevant finding of the Hon’ble High Court (supra) is reproduced as under:

21. The position emerging from the above decisions is that it is not necessary for the Respondent to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for the Respondent to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred “wholly and exclusively for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above.”

5.6 On the contrary, learned DR relied on the order of the lower authorities and submitted that the services are in the nature of the duplicate in view of covered by the warranty and thus the learned TPO has correctly determined the ALP at Nil. 5.7 We have heard the rival submissions of the parties and perused the relevant material on record. We find that the Hon’ble Delhi High Court in the case of EKL Appliances (supra) has held that the TPO is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure by the learned TPO is not authorized. The relevant finding of the High Court is reproduced as under: “22. Even Rule 10B(1)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the Respondent to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the Respondent in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. ” The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow’ the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/ brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow’ the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised.”

5.8 In the instant case, the assessee has incurred expenditure and not making payment of mark-up is not adverse to the entity in Indian Jurisdiction. The assessee has claimed the expenditure paid by the AE on its behalf. The contention of the TPO is that the assessee was not required to incur the said expenses. But it was under jurisdiction of the Assessing Officer whether particular expenditure was incurred wholly and exclusively for the purpose of business and not in the domain of the TPO to hold that in view of the warranty etc., the assessee was not required to incur expenditure on firewall charges. The contention of the assessee seems plausible that motors were required to checked for content of moisture acquired in transport from India to the USA, i.e., the destination point and it was the responsibility of the assessee to provide defect free motors to the end customers. Thus, respectfully following the finding of the Hon’ble Delhi High Court (supra), we delete the transfer pricing adjustment of Rs. 2,54,42,211/-. Accordingly, the appeal of the assessee is allowed. Assessment Year: 2009-10

1. That the Learned Assessing Officer (‘Ld. AO’) erred in passing the impugned draft assessment order and the Learned Dispute

Resolution Panel (‘Ld. DRP’) erred in passing directions under Section 144C of the Income Tax Act, 1961 (‘the Act’) confirming the draft assessment order. On the facts and circumstances of the case and in law, the Ld. AO erred in assessing the income of the Appellant at Rs.49,68,88,400 as against the returned income of Rs.32,37,64,910.

2.1 not appreciating the characterization of the entities involved in the transaction and disregarding the fact that the conduct of the Appellant conforms to the allocation of risk i.e. the entity bearing product liability risk is undertaking decisions in relation to the same; 2.2 not appreciating the nature of the transaction and the functions being performed by the entities involved in relation to the transaction; 2.3 questioning the commercial/business wisdom of the Appellant for undertaking the said transaction; and 2.4 not appreciating the fact that no adjustment is warranted as no benefit has been passed on to the Associated enterprise since it is recovering exactly the same amount that has been paid to independent third party.

5. That on the facts and in the circumstances of the case and in law, both the Ld. AO and the Ld. DRP erred in denying the Appellant’s claim of deduction under section 10B of the Act amounting to Rs.15,41,25,434 in respect of its newly established hundred percent Export Oriented Unit despite the fact that the Appellant satisfied all the conditions laid down under section 10B of the Act.

5.1 That on the facts and in the circumstances of the case and in law, both the Ld. AO and the Ld. DRP erred in rejecting the Appellant’s claim of the deduction under section 10B of the Act ignoring the factual and legal position that the new unit is a hundred percent Export Oriented Unit duly approved by the prescribed authorities and a separate undertaking for the purpose of deduction under section 10B of the Act.

5.2 That on the facts and in the circumstances of the case and in law, both the Ld. AO and the Ld. DRP erred in holding that no separate industrial unit came into existence for manufacturing of new articles or things.

5.3 That on the facts and in the circumstances of the case and in law, both the Ld. AO and the Ld. DRP erred in holding that the new hundred percent Export Oriented Unit was an expansion of the existing unit and not an integrated new unit.

5.4 That on the facts and in the circumstances of the case and in law, both the Ld. AO and the Ld. DRP erred in holding that the Appellant has not started a new hundred percent Export Oriented Unit and that the Appellant did not enter into manufacturing of any new product but only increased the product range of electric motors.

6. That on the facts and in the circumstances of the case and in law, both the Ld. AO and the Ld. DRP erred in not following the order passed by the Hon’ble Commissioner of Income-tax (Appeals) [‘CIT(A)’] for previous assessment years (‘AY’) i.e. AY 2003-04 to AY 2006-07, wherein the Hon’ble CIT(A) has upheld the Appellant’s claim of deduction under section 10 B of the Act and deleted the addition made on this account.

7. That the Ld. AO erred on facts and in law in levying interest under section 234B of the Act.

also there are two issues involved, i.e., is transfer pricing adjustment and disallowance of deduction under Section 10B of the Act. We have already adjudicated both the issues in the foregoing paras in (AY: 2007-08). The facts and circumstances of the case in (AY: 2009-10) are identical to the facts and circumstances of the case in (AY: 2007- 08). Thus, to have consistency in our decision, following our findings in assessment year 2007-08, grounds raised by the assessee on both the issues are allowed mutatis mutandis. In the result, the appeal of the assessee is allowed.

8. To sum up, both appeals of the assessee are allowed. Order pronounced in the open court on 19th February, 2020.