DCIT, BANGALORE vs. M/S CONTINENTAL AUTOMATIVE COMPONENTS (INDIA) PVT. LTD.,, BANGALORE

Per Jason P. Boaz, Accountant Member

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 2 of 19 2. Briefly stated, the facts of the case are as under:

2.1 The assessee company is a subsidiary of Continental Automotive GMbh, Germany and the ultimate holding company is Continental AG, Germany. The assessee is engaged in the manufacture and trading of various types of automotive components / auto ancillary products. The assessee also provides application / specific contract R & D activities with regard to developing and porting of software, creation of software specification, etc. The assessee filed its return of income for Assessment Year 2011-12 on 30.11.2011 declaring NIL income and current losses of Rs.66,25,31,764/-. The return was processed under section 143(1) of the Act and the case was subsequently taken up for scrutiny for this Assessment Year. The Assessing Officer (AO) made a reference under section 92CA of the Act to the Transfer Pricing Officer (TPO) for determination of the arm’s length price (ALP) of the assessee’s international transactions with its Associated Enterprises (AE) in the year under consideration. The assessee has reported three segments, namely manufacturing, trading and services segments. While the international transactions in the manufacturing and trading segments were found to be at arms length by the TPO, the TPO made certain adjustments to the service segment of the assessee.

2.2 In respect of the services segment, the assessee classified its services as contract R & D services. The assessee conducted its comparability analysis applying TNMM as the most appropriate method (MAM) with operating profit to total cost as the PLI (-10.8%), and chose the following 5 companies as its comparable companies:-

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 3 of 19 Sl. No. Name of Comparable Company 1. Accuspeed Engineering Ltd., 2. Axis – IT & T Ltd., 3. CSS Technology Ltd., 4. Chakkillam Infotech Ltd., 5. Cades Digitec Pvt. Ltd.,

After analyzing the margins of such comparable companies, the assessee determined its transactions with AEs to be at arms length.

2.3 The TPO, however, rejected the assessee’s TP Study and performed his own comparability analysis by adopting certain filters and using current years data only and selected the following 10 companies as comparables to the assessee, after characterizing the services rendered by the assessee as ITES.

Sl. No. Name of the case OP/OC 1. Accentia Technologies Ltd. 28.89% 2. Acropetal Technologies 26.86% 3. Cosmic Global Ltd. 9.81% 4. e4e Healthcare(capitaline) 12.38% 5. I C R A Online Ltd.(seg) 34.21% 6. Jeevan scientific technology Ltd 70.66% 7. Infosys B P 0 Ltd. 17.89% 8. Jindal Intellicom (capitaline) 11.13% 9. Mindtree Ltd (seg) 10.76% 10. iGate Global solutions Ltd 25.07% Average Margin 24.77%

Having carried out his own comparability analysis, the TPO proceeded to conclude the TP analysis by characterizing the services rendered by the IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 4 of 19 assessee to its AEs as ITES and proposed an adjustment of Rs.11,19,95,059/- as per his order under section 92CA of the Act dated 29.01.2015.

2.4 After receipt of the TPO’s order under section 92CA of the Act, the AO passed the draft order of assessment under section 143(3) r.w.s. 144C of the Act dated 30.03.2015, wherein the assessee’s loss was determined at Rs.37,68,41,545/- in view of, inter alia, the TP additions of Rs.11,19,95,059/-.

2.5 Aggrieved by the draft order of assessment dated 30.03.2015 for Assessment Year 2011-12, the assessee filed its objections thereto before the DRP. The DRP issued its directions thereon under section 144C(5) of the Act dated 14.12.2015. Pursuant thereto, the AO passed the impugned final order of assessment under section 143(3) r.w.s. 144C of the Act dated 14.01.2016, wherein the assessee’s loss was determined at Rs.31,80,37,446/-; which, inter alia, included the TP adjustment of Rs.8,43,63,985/-.

3. The assessee, being aggrieved by the final order of assessment dated 14.01.2016 for Assessment Year 2011-12, has filed this appeal before the Tribunal, wherein it has raised the following grounds:-

I. Transfer Pricing The grounds mentioned hereinafter are without prejudice to one another. The learned Assessing Officer ("learned AO"), learned Transfer 1. Pricing Officer ("learned TPO") and the Honourable Dispute Resolution Panel ("Hon'ble DRP") erred in proposing an adjustment of INR 8,43,63,985/- to the arm's length price of the Appellant's international transactions with Associated Enterprises ("AEs") with respect to the services rendered by the Appellant u/s 92CA of the Income-tax Act, 1961 ("the Act").

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 5 of 19 The learned TPO / Hon'ble DRP erred in rejecting summarily the 2. Transfer Pricing ("TP") documentation maintained by the Appellant by invoking provisions of sub-section (3) of Section 92C of the Act contending that the information or data used in the computation of arm's length price is not reliable or correct and conducting a fresh comparability analysis without appreciating the fact of impossibility of performance. The learned TPO / Hon'ble DRP erred in rejecting the economic analysis 3. performed by the Appellant in the TP documentation justifying the arm's length nature of the international transaction pertaining to services rendered by the Appellant. The learned TPO / Hon'ble DRP erred in comparing the Appellant with 4. functionally different comparable companies engaged in providing diverse IT enabled services without appreciating that the companies are rendering services which are not comparable to the services being rendered by the Appellant. The learned TPO / Hon'ble DRP erred in comparing the Appellant 5. to functionally different comparable companies providing diverse IT enabled services and thereby erred in including additional comparable companies which do not satisfy the test of comparability. Specifically, the following company should have been rejected: a) Accentia Technologies Limited b) ICRA Online Limited c) Jindal Intellicom Limited

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 6 of 19 Silverline Technologies Ltd. k) Thinksoft Global Services Ltd. l) Evoke Technologies Ltd. m)

The learned TPO / Hon'ble DRP erred in rejection / modification of 7. filters applied by the Appellant while undertaking comparability analysis and in conducting a fresh comparability analysis by applying additional filters for determination of the arm's length price for international transactions pertaining to services rendered by the Appellant. The learned TPO / Hon'ble DRP erred in not considering the multiple 8. year / prior year financial data of comparable companies while determining the arm's length price. The learned TPO / Hon'ble DRP ought to have applied an upper limit 9. for sales turnover filter of Rs.200 Crores in the comparability analysis.

10. The learned TPO / Hon'ble DRP erred in applying export earning filter of 25% of the total sales, leading to a narrower comparable set.

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 8 of 19 c. The learned AO has erred in concluding that approval under section 35(2AB) of the Act from the prescribed authority such as the -DSIR] is mandatory Department of Scientific and Industrial Research [ for claiming expenses in the nature of such annual license fee. d. The learned AO and Hon'ble DRP has failed to appreciate that the annual license fees expenditure has been claimed as a deduction under section 37(1) of the Act which does not arrant any approval from DSIR and the said expenditure is solely for the purpose of business and are recurring in nature [from the second year of incorporation of the Company]. e. The learned AO and Hon'ble DRP has erred in not appreciating the fact that the applicable withholding tax on the payments has been deducted and remitted. f. The learned AO has erred in contending that the expenditure incurred by the Appellant would give enduring benefits and such expenditure would be capital in nature. g. Notwithstanding and without prejudice to the above, even if the said expenses are held as vital expenses relating to R&D resulting in an enduring benefit, the Appellant must be lowed deduction under section 35(1)(iv) of the Act. h. Notwithstanding and without prejudice to the above, even if the said expenses are held as capital in nature, the Appellant would be eligible to claim depreciation under section 32 of e Act at the rate of 25% on the amount capitalized as license fees, for income tax purposes.

4.1.1 In the course of proceedings before us, the learned AR of the Assessee submitted that the assessee has three segments namely manufacturing, trading and services segment. The transactions of the manufacturing segment and trading segment have been accepted to be at arms length by the TPO. However, TPO has made a TP adjustment to the services segment; treating the services rendered by the assessee as Information Technology Enabled Services (ITES). According to the learned AR, the assessee renders application / specific contract R & D services to its AEs which has been characterized as Design and Engineering Services in the TP

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 9 of 19 Study conducted by the assessee. The TPO, after recording the fact that the assessee renders Design and Engineering Services, proceeded to reject the assessee’s TP study and conducted his own TP analysis by characterizing the services rendered by the assessee as ITES.

4.1.2 In this regard, the learned AR referred to ground Nos. 3 and 4 of the assessee’s appeal. It was submitted that this issue of characterization of the services rendered by the assessee was before the Co-ordinate Bench of this Tribunal in the assessee’s own case for Assessment Year 2009-10, wherein the Tribunal in its order in IT(TP)A Nos. 165 and 254/Bang/2014 dated 28.09.2017 remanded the issue back to the TPO for fresh consideration (copy of the same was placed on record).

4.2.1 We have heard / considered the submissions made by both parties and examined the issue before us i.e., the characterization of services rendered by the assessee to its AEs. We find that the assessee had characterized the services rendered by it as “Design and Engineering Services” which fact has been recorded in the TPO’s order. The TPO, however, characterized the services rendered as “ITES” and benchmarked the same in his TP study /analysis carried out by him. The Co-ordinate Bench of this Tribunal, in the assessee’s own case for Assessment Year 2009-10 (supra), had remanded the issue of characterization of services rendered by the assessee back to the file of the TPO for fresh examination; holding as under at paras 4 and 5 thereof:-

“2. Regarding the appeal of the assessee, it was submitted by ld. AR of assessee that ground nos. 1 and 2 are general. Regarding ground no. 3A, he submitted that as per this ground, the assessee is requesting for inclusion of three companies but now he is requesting for inclusion of only one company i.e. R Systems International Ltd. and as per ground no.

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 10 of 19 3B, the request of the assessee is for inclusion of 4 companies i.e. Infosys BPO Ltd., Accentia Technologies Ltd., Cosmic Global Ltd. and Eclerx Services Ltd. Regarding ground nos. 3 to 7, he submitted that these grounds are not pressed and accordingly these grounds are rejected as not pressed and part of ground 3A is also rejected as not pressed. It was submitted that as per Para no. 15.1 of the order of DRP, it was held that the company R Systems International Ltd. cannot be considered as a comparable because the financials of this company is for a period of 12 months ending December 2008. He submitted that it is now a settled position of law that even if a comparable company is having different financial year and data for the period from April to March can be made available then such company can also be considered as a good comparable. He submitted that this issue may be restored back to the file of TPO for fresh decision. Regarding the request for exclusion of 4 companies, it was submitted that on this issue also, the matter may be restored back to the file of TPO for fresh decision because it is noted by the TPO on page no. 5 of his order that in view of the limited information provided by the taxpayer, activity of this company was considered as that of ITES although the assessee is providing application / specific contract R & D services. It was submitted that if the matter is restored back to the file of TPO for fresh decision, the assessee will provide all the information required by the TPO to decide this aspect first as to whether the assessee is engaged in ITES or in research activities. The ld. DR of revenue supported the orders of authorities below.

4.2.2 Respectfully following the decision of the Co-ordinate Bench of this Tribunal in the assessee’s own case for Assessment Year 2009-10 (supra), we deem it appropriate to remand the issue of characterization of services rendered by the assessee, to the file of the AO for de-novo examination and decision on the characterization of the services rendered by the assessee for this Assessment Year also.

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 11 of 19

CORPORATE TAX

6. Ground No.1 (a to g) - Provision for Warranty 6.1.1 In respect of these grounds (supra), the learned AR submitted that the AO has disallowed the provisions for warranty amounting to Rs.3,61,87,333/- by holding that the assessee had failed to furnish the scientific basis on which the provision for warranty has been created. The DRP upheld the disallowance made by the AO.

6.1.2 Before us, it was submitted that for Assessment Year 2009-10, the DRP had allowed the provision for warranty by giving a finding that the provision has been made on a scientific basis. However, Revenue carried the matter to the Tribunal and the Co-ordinate Bench of this Tribunal in its order in IT(TP)A No.165 and 254/Bang/2014 dated 28.09.2017 for Assessment Year 2009-10 had remanded the matter back to the file of the AO for fresh determination.

6.2.1 We have considered the submission of both the parties and perused the material on record; including the judicial pronouncement cited. In Assessment Year 2009-10, the DRP had allowed the assessee’s claim on IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 12 of 19 this issue. Revenue had raised the issue before the Tribunal in grounds 3 and 4 of Revenue’s appeal, which is at page 4 of Tribunal’s order (supra) and which is extracted hereunder:-

“3. The DRP erred in directing the AO to delete the disallowance of provision for warranty amounting to Rs. 1,09,46,000/ without appreciating that a comparison of the provisions and the actual expenses do not disclose any scientific relationship amongst them and the claim was only an estimation which cannot be held as scientific and the SC in the case of Rotork Controls India (P) Ltd. has held that the claim should be scientific.

6.2.2 The Co-ordinate Bench of the Tribunal in its order for Assessment Year 2009-10 disposed off the grounds 3 and 4 (supra) by remanding the issue back to the file of the AO. The relevant portion of the decision of the Co-ordinate Bench for Assessment Year 2009-10 (supra) at paras 9 and 10 of its order is extracted hereunder:-

“9. Regarding corporate tax issue involved in ground nos. 3 and 4, the ld. DR of revenue supported the order of TPO whereas the ld. AR of the assessee supported the order of CIT(A). He also submitted that this issue is squarely covered in favour of the assessee by the judgment of Hon’ble Apex Court rendered in the case of Rotork Controls India (P) Ltd. Vs. CIT as reported in 314 ITR 62 wherein it was held that if the estimation of the liability on account of warranty is reliable, it should be allowed. At this juncture, the bench wanted to see the details of provisions made by the assessee. The ld. AR of assessee submitted the details of the warranty expenses as per Profit & Loss Account along with opening balance and closing balance and IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 13 of 19 it was pointed out by him that for the present year, the amount debited by way of provision is Rs. 109.46 lakhs and the actual expenditure is Rs. 98.68 lakhs. But the bench pointed out that in Assessment Year 2011-12 and 2012-13, the amount debited to P&L account was Rs. 528.64 lakhs and Rs. 783.67 lakhs respectively. Whereas the actual expenditure was only Rs. 166.77 lakhs and Rs. 262.34 lakhs respectively and this goes to show that the estimation of the assessee is not in line with the actual expenditure incurred by the assessee in these years at least and the assessee has to make provision on same basis in all years and therefore, in the present year also, the basis of provision cannot be said to be scientific although there may be small difference in the amount of provision and actual expenditure. The bench also wanted to see the basis of computation done by the assessee for making the provision. In reply, it was submitted by ld. AR of the assessee that these details are not readily available and therefore, this matter may also be restored back to AO for fresh decision.

6.2.3 From the above, we find that the Co-ordinate Bench of the Tribunal in its order for Assessment Year 2009-10 (supra) has remanded the issue back to the file of the AO and while doing so, has, inter alia, considered the provisions made for Assessment Year 2011-12; the year under consideration in this appeal. In the above view of the matter, we deem it appropriate to respectfully follow the aforesaid decision of the Co-ordinate Bench of this Tribunal in the assessee’s own case for Assessment Year 2009- 10 (supra) and remand the issue of provision for warranty to the file of the AO

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 14 of 19 for de-novo examination and adjudication with the same directions that the assessee should bring on record all the details evidences to establish that the provisions made by the assessee is on scientific basis and the AO should pass a speaking and reasoned order after providing the assessee adequate opportunity of being heard and to file details / submissions which shall be duly considered by the AO. We hold and direct accordingly. Consequently, ground 1 (a to g) raised by assessee on the issue of provision for warranty is treated as allowed for statistical purposes.

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 Page 15 of 19 expenses; which is for consideration before us. The assessee has debited these expenses in the Profit & Loss 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.”

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 16 of 19 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 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.

7.2.4 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 IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 17 of 19 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 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.

Revenue’s appeal in IT(TP)A No.425/Bang/2016 – Assessment Year 2011-12 9.1 In this cross appeal, Revenue has raised the following grounds:-

1. M/s Infosys Technologies Ltd. A The Hon'ble DRP has erred in fact in rejecting the company as a comparable on the grounds that it is functionally different when the primary source of income of the comparable is from provision of software development services. b) The Hon'ble DRP has erred while seeking the exact comparability as mentioned above the DRP was right in fact and in law in imposing condition beyond law whereas the requirement of law is to acknowledge only those differences that are likely to materially affect the margin. c) The Hon'ble DRP has erred in fact and law in disregarding the position of law that there could be differences between the IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 18 of 19 enterprises compared under the TNMM method that are not likely to materially affect the price or cost charged or the profits accruing to such enterprises.

2. M/s. Acropetal Technologies Ltd. a) In the facts and circumstances of the case, the Hon'ble DRP has erred in is correct in holding that the M/s Acropetal Technologies Ltd cannot be taken as comparable, when it satisfies all the qualitative and quantitative filters adopted by the TPO. b) The Hon'ble DRP has erred in applying "onsite revenue filter" without appreciating the fact that the function carried out is "Software Development" irrespective of whether onsite or offshore. The Hon'ble DRP has erred in correct in excluding c) M/s Acropetal Technologies on the ground that it has significant onsite revenue without appreciating the fact that onsite development of software entails more cost and thereby results in lower profit margins. The Hon'ble DRP has erred in seeking exact comparability while d) searching for comparable companies of the assessee under TNMM method whereas requirement of law and international jurisprudence require seeking similar comparable companies.

3. M/s. Jeevan Scientific Technology Limited a) The Hon'ble DRP has erred in facts and law in excluding the company as a comparable, on the ground of failing the service income filter, when only the segmental results have been considered for comparability 9.2 In view of our decision in the assessee’s cross appeal in (supra), setting aside the entire Transfer Pricing issues to the file of the TPO for denovo examination and adjudication by following the decision of the Co-ordinate Bench of this Tribunal in the assessee’s own case for Assessment Year 2009-10 in IT(TP)A No.165 and 254/Bang/2014 dated 28.09.2017, the grounds raised by Revenue, all being related to transfer pricing issues are rendered academic and therefore are not being adjudicated at this stage.

IT(TP)A No. 457/Bang/2016 IT(TP)A No. 425/Bang/2016 Page 19 of 19 10. In the result, both the assessee’s appeal for Assessment Year 2011-12 and the Revenue’s cross appeal are allowed for statistical purposes.

Pronounced in the open court on 12th April, 2019.