DY.C.I.T., BANGALORE vs. LENOVO INDIA PVT. LTD.,, BANGALORE

Per Bench : Cross appeals are directed against the assessment order dt.30.01.2015 passed

under Section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (in short 'the Act')

2 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 in pursuant to the directions of the Dispute Resolution Panel (in short ‘DRP’)

dt.22.12.2014 as well as appeal by the assessee against the order passed under

Section 154 of the Act for the Assessment Year 2010-11. The assessee has also

filed appeal against the order dt.18.10.2011 of Commissioner of Income Tax

(Appeals) for the Assessment Year 2007-08.

wherein the assessee has raised the following grounds :

“ The order dated October 18, 2011 passed by the learned Commissioner of Income-tax 1. (Appeals)-I, Bangalore under section 250 of the Income-tax Act, 1961 is bad in law and on facts. Provision for Warranty 2. 2.1 The learned CIT(A)-I has erred in law and on facts in disallowing an amount of Rs 149,126,412 in respect of provision for warranty for the FY 2006-07 without appreciating the fact that Assessee maintains its books on a mercantile basis of accounting and that the said warranty provision has been created on a scientific manner, having due regard to the nature of activity, its global warranty accrual processes and the industry requirement in which the Assessee operates. 2.2 The learned CIT(A)-I has erred in law in disregarding the decision of the Honorable Supreme Court in the case of Rotork Controls Private Limited and has proceeded to disallow provision for warranty which has been created on a scientific and consistent basis. The learned CIT(A)-I has erred in law, in disregarding the Honourable Delhi High Court 2.3 decision which has held that formula used globally for computing the provision for warranty is acceptable as a scientific formula and the computation of provision based on such formula is an allowable expenditure. 2.4 The learned CIT(A)-I has erred in law in relying on his decision in Apple India (P) Ltd, wherein the said decision has been reversed by the Honourable Bangalore Tribunal in the case of Apple India (P) Ltd. 3 Disallowance of Marketing support fees as capital expenditure 3.1 The learned CIT(A)-I has erred in law in arbitrarily disallowing an amount of Rs 139,237,553 being the amounts paid to IBM as marketing support fees without

3 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 considering the fact that Lenovo India, in its first few years of operation in India, did not have marketing and logistics network in India for the sale of desktops and laptops and therefore it was required to contract, for a period of five years, with IBM India for provision of logistic support and sales force for marketing and distribution of Lenovo India’s products to retain the market share in India. 3.2 The learned CIT(A)-I has erred in law and on facts in arbitrarily concluding that marketing support fee paid by Lenovo India is capital in nature. 3.3 The learned CIT(A)-I has erred in law and on facts in relying on the cases of Assam Bengal Cement Co. Ltd.1 and Woodhead and Sons Ltd.2 as the facts in those cases are different from Lenovo India’s case. 4 Disallowance of Superannuation fund 4.1 The learned CIT(A)-I has erred in law in taxing an amount of Rs 4,073,620 towards disallowance of superannuation fund payments under section 40A(9) read with section 36(1)(v) of the Act. 5 The learned CIT(A)-I has erred on facts in computing the total loss of the Company at Rs 47,830,738. The Assessee craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before or at, the time of hearing, of the appeal, so as to enable the Honourable Bench of the Income Tax Appellate Tribunal to decide this appeal according to law.”

adjudication.

learned CIT, DR and carefully perused the material on record. At the outset, we

note that an identical issue was considered by this Tribunal in assessee's own case

for the Assessment Year 2006-07 as well as for the Assessment Year 2011-12.

We find that for the Assessment Year 2006-07, the Tribunal in the first round of

4 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 appeal vide order dt.16.3.2012 in ITA No.1457/Bang/2010 remanded this issue to

the assessing authority to reconsider its affairs in the light of the guidelines issued

by the Hon'ble Supreme Court in the case of Rotok Controls India Pvt. Ltd. Vs.

CIT 314 ITR 62. The issue was again brought before this Tribunal for the

Assessment Year 2007-08 and vide its order dt.30.5.2016, the Tribunal decided

this issue in favour of the assessee in IT(TP)A No.582/Bang/2015. We further

note that this issue was again considered by this Tribunal in assessee's own case

for the Assessment Year 2011-12 vide order dt.21.10.2016 in IT(TP)A

No.373/Bang/2016 in para 10 as under :

“ 10. We heard rival submissions and perused material on record. The only issue in this ground of appeal is whether provision for warranty expenditure is allowable. It is no doubt true if the tests evolved by the Hon’ble Supreme Court in the above case are satisfied then the provision for warranty expenditure is allowable. The AO had compared the current year provision vis-à-vis actual expenditure incurred during the year of warranty. According to the learned counsel, the warranty expenditure incurred during the year is out of the provision created in the earlier year. Therefore the comparison of provision for the year vis-à-vis the actual expenditure incurred during the year does not stand to any reason. In this connection, the findings of the co-ordinate bench in the assessee’s own case for assessment year 2006-07 are relevant which are quoted below: “16. We have perused the materials and heard the rival contentions. Question before us is whether assessee had made the provisioning for warranty in a scientific manner. It is not disputed that in the impugned assessment year it had started doing the business of sale of laptops and desktops. Obviously assessee had no historical data with it. It is also not disputed that assessee had taken over this business from IBM, who had substantial experience in such business. Hence if the assessee relied on the methodology followed by IBM for working out the warranty provision we cannot say that it was incorrect. There is no case for the Revenue that any provisioning made by IBM in respect of such business in any earlier years were disallowed for a reason that it was unscientific. It is true that assessee had

5 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 adopted two factors namely, repair action rate and cost per claim from IBM data available at Asia Pacific Level. It might also be true that assessee had not produced records relating to IBM to show that these rates were correctly worked out by IBM. Nevertheless a look at the warranty provisioning table of the assessee for the succeeding assessment years reveals the following :

6 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 There is much strength in the argument of the Ld. AR that provision done for a year should be compared with the actual spending in the succeeding year. This is for the simple reason that expenditure incurred against warranty given on sales made in any given year would be reflected in the succeeding year, when the provisioning is done on the basis of machine months. Assessee had done the provisioning based on machine months. If by application of the formula of multiplying machine months with repair action rate and cost per claim, an excessive warranty provisioning had resulted, then definitely in the succeeding year the expenditure incurred on warranty would be much less. The table above would show that expenditure on warranty was higher in almost all succeeding years except financial year 2009-09. In such circumstances we cannot say that assessee had followed a method which was not scientific. We are of the opinion that the three conditions set out by the Hon’ble Apex Court in the case of Rotork Controls India (Pvt) Ltd have been satisfied by the assessee, viz., establishing that there is a present obligation on account of a past event, working out the probable estimate of the outflow of the resources required and substantiating the reliability of such estimate. Especially so since the assessee was mandatorily required to follow AS-I and principles of prudence stipulated in such AS-I required provisioning for all known liabilities even if it could not be determined with certainty, but was made based on available data. We therefore delete the addition made by the AO disallowing the provision for warranty. Ground 7 of the assessee stands allowed. It is worth mentioning that the co-ordinate bench has considered the historical data pertaining to financial year 2005-06 to 2011-11 and came to the conclusion that the provision was made based on historical data and following scientific method. Therefore, we do not find any reason to interfere with the conclusion reached by the co-ordinate bench. Accordingly, we hold that the provision for warranty expenditure is allowable. This ground of appeal is allowed.” Thus the Tribunal has taken a consistent view on this issue. The ld. Senior Counsel

has also relied upon the decision dt.10.4.2013 of Hon'ble jurisdictional High Court

in the case of CIT Vs. IBM India Limited for the Assessment Year 1998-99 wherein

the Hon'ble Supreme Court has held that the conditions as stipulated by the

Hon'ble Supreme Court in the decision in the case of Rotork Controls India Pvt.

7 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 Ltd. Vs. CIT (supra) were found to be fulfilled and no case of interference with

the finding of the Tribunal is made out. It is pertinent to note that in this case the

assessee has acquired this business from IBM and for the first year after

acquisition i.e. for the Assessment Year 2006-07, the claim of the assessee for

provision of warranty was based on the historical data of IBM. Thus in view of the

above facts and circumstances of the case as well as by following the decision of

this Tribunal in assessee's own case, we decide this issue in favour of the assessee

and allow the claim of the assessee on account of provision for warranty which

was found to be based on scientific basis and method.

marketing support service charges paid by the assessee to IBM.

CIT, DR and carefully perused the material on record. The Assessing Officer has

disallowed the claim of Marketing Support Service Charges by treating the same

as capital in nature as it was connected with the business acquired by the

assessee from IBM. The CIT (Appeals) confirmed the disallowance made by the

Assessing Officer.

Tribunal in assessee's own case for the Assessment Year 2006-07 and again for

8 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 the Assessment Year 2008-09 vide order dt.14.8.2014 in ITA Nos.607 &

542/Bang/2013 in paras 16 & 17 as under :

“ 16. The claim of the assessee was with regard to marketing support and transition fees amounting to Rs.6,78,19,000 paid to M/s. IBM India Pvt. Ltd. towards various services rendered by the said company to the assessee. This was disallowed for by the Assessing Officer for the reason that the expenditure was incurred by the assessee for retaining the customer / dealer base of M/s. IBM India Pvt. Ltd. which resulting in acquiring an enduring benefit. In its appeal before the CIT (Appeals) the argument of the assessee was that similar issue was decided by this Tribunal in assessee's own case for the Assessment Year 2006-07. Learned CIT (Appeals) relying on the decision of the Tribunal mentioned supra, allowed the claim. Ld. DR has fairly admitted that the issue stood covered in favour of the assessee. However, according to him, the marketing support service agreement was only an appendix to the main agreement for acquiring business form M/s. IBM India Pvt. Ltd. and therefore, the outgo was essential in the capital field. Nevertheless, we find that co-ordinate Bench of the Tribunal has allowed the claim of the assessee in its order dt.16.3.2012 in ITA No.1457(B)/10 for Assessment Year 2006-07, holding as under :

“ Having heard both the parties and having considered their rival contentions and the material on record, we find that the question before us is whether the payment for the marketing support agreement is revenue or capital in nature? The assessee has filed the copy of the marketing support agreement which is in paper book No.2 at pages 23 to 120. The article 2 of the said agreement describes the market support services to be delivered by IBM. From a reading of the said services, it is clear that the IBM was to provide the services to the purchaser as provided in the services description attachment to facilitate the sale of the products by the assessee and to extend services to the customers through one or more of its subsidiaries or 3 rd parties under contract with the seller/IBM or one of its subsidiaries. Thus, it is clear that the services rendered by IBM are for smooth and efficient carrying on of the business of the assessee for a period of 5 years. This might give an enduring benefit to the assessee but every activity which gives enduring benefit to the assessee would not get the character of capital nature. It has been held by the various high courts in a catena of decisions that the enduring benefit is not the only criteria to decide the nature and character of an expenditure. The necessary test is whether it is for acquisition of any capital asset or for the purpose of carrying on the business, deriving revenue from it. The marketing support services cannot however be considered as acquisition of a capital asset. The support services are for the purpose of sale of the products manufactured by the assessee and, therefore, it is clearly established that it is for efficient running of the business and deriving revenues there-from. In such circumstances, we are inclined to hold that the fees paid by the assessee for marketing support services rendered by IBM, is clearly revenue in nature and is allowable as deduction u/s 37 of the Income-tax Act.”

9 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 17. Respectfully following the above, we dismiss the appeal filed by the revenue.”

It is clear that the Tribunal has taken a consistent view on this issue for the

Assessment Year 2006-07 and it was followed for the Assessment Year 2008-09. It

is petinent to note that the market support service charges are paid under the

same agreement as for the Assessment Years 2006-07 & 2008-09. Therefore

following the decision of this Tribunal for the earlier Assessment Year as well as in

the subsequent Assessment Year we decide this issue in favour of the assessee

and allow the claim of the assessee.

the payment to superannuation fund on the ground that the fund was not

approved by the competent authority. On appeal, the CIT (Appeals) has

confirmed the disallowance made by the Assessing Officer on the reason that

though the approval was given on 13.7.2017 w.e.f. 13.03.2007 however the

payment was made on 7.4.2007 when the assessee was yet to get the approval.

Thus on the principle of impossibility the deduction was denied.

accepted the fact that the approval was granted vide order dt.13.7.2007 w.e.f.

13.3.2007. Therefore the payment made by the assessee after the approval

10 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 granted w.e.f. 13.3.2007 is an allowable deduction as it was the payment on or

before the filing of return under Section 139(1) of the Act. The ld. Senior Counsel

has pointed out that the CIT (Appeals) has denied this deduction only on the

ground that on the date of payment i.e. 7.4.2007, the assessee was yet to get the

approval whereas if the assessee would have made the payment after 13.7.2007

the date of approved still the claim of the assessee was allowable deduction as it

was prior to the due date of filing the return under Section 139 as per the

provisions of section 43B of the Act.

upon the orders of the authorities below.

The CIT (Appeals) has confirmed the disallowance by citing the reasons in para 7.2

as under :

“ 7.2 During appellate hearing the A Rs filed a copy of approval which shows that approval was given on 13.7.2007 w.r.e from 13.3.2007. On enquiry it was also pointed out that on 7.4.2007 such fund was paid to the credit of Govt. I consider this an impossibility because on 7.4.2007, the appellant was yet to get the approval and the number. Thus on the principles of impossibly the deduction is not allowed. Hence addition is upheld. Grounds of appeal is dismissed.”

From the above finding of the CIT (Appeals) it is clear that the approval was given

to the fund on 13.07.2007 with retrospective effect from 13.3.2007. Therefore

11 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 the approval to the assessee was given and effective before the end of the

financial year relevant to the assessment year under consideration. The assessee

paid the amount to the credit of the Govt. on 7.4.2007 which is well within the

limit as prescribed under Section 43B of the Act. Therefore once the assessee has

paid the amount in the fund before the time period prescribed under Section 43B

and the fund was approved w.e.f. 13.3.2007 then there is no plausible reason to

reject the claim of deduction on this account. Accordingly, in the facts and

circumstances of the case where the assessee has complied with all the requisite

conditions, we allow the claim of the assessee and consequently the orders of the

authorities below are set aside.

Now we take up the appeal of the assessee for A.Y. 2010-11.

Section 143(3) r.w.s. 144C of the Act. The assessee has raised the following

grounds :

Transfer Pricing Adjustments

a. The learned AO and the TPO have erred in passing an order without following the clear directions of the Honorable Dispute Resolution Panel (“DRP”), which is directly in violation of section

12 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 144C(10) of the Act and hence liable to be struck down as beyond the jurisdiction of the AO and as being bad in law.

b. The learned AO and the TPO have erred in adopting the Transaction Net Margin Method (“TNMM”) as the Most Appropriate Method (“MAM”) when the DRP, based on elaborate reasons and after examining the merits of the appellant’s case had held that the Comparable Uncontrolled Price (“CUP”) method was the MAM for the benchmarking of the import transactions undertaken by the appellant during the year.

c. The learned AO and the TPO have erred in rejecting the CUP method despite the appellant’s request for rectification of the apparent error in the impugned order of the TPO/AO.

d. The learned AO and the TPO have erred in concluding that there was a contradiction in the order of the DRP, when it is evident from the clear direction of the DRP that CUP method was upheld as the MAM for benchmarking the transactions, based on the merits of the appellant’s case.

• It is also evident that there is no contradiction with the order of the Honourable Income-tax Appellate Tribunal (“ITAT” or “the Tribunal”) in the appellant’s own case for AY 2006-07, wherein it was held that when the appellant’s transactions for the AY 2007-08 and 2008-09 have been accepted to be at arm’s length, the TP analysis conducted by the appellant for AY 2006-07 under the CUP method should also be accepted to be at ALP.

e. The learned AO and the TPO have erred in not recognizing the settled principle in law that the onus and right of choosing the MAM for benchmarking the transaction rests with the Appellant and that the method cannot be rejected by the AO/TPO arbitrarily or without adequate reasons.

• It would be evident from the TP and assessment orders for AY 2007-08 and 2008-09 in the appellant’s case that the appellant’s transactions have been accepted to be at arm’s length and there is no rejection of the MAM adopted by the appellant.

f. Without prejudice to the other grounds of appeal, the learned AO and the TPO have erred in not considering that the DRP had not merely followed the decision of the ITAT in the appellant’s case for AY 2006-07, but had independently examined the appellant’s facts for the year and upheld the CUP method as the MAM.

a. Without prejudice to the above, the learned TPO has erred in law and on facts in rejecting the Transfer Pricing (“TP”) documentation which has been prepared by the Appellant in the manner as contemplated under the relevant provisions of the Act and the Income-tax Rules,1962 (“the Rules”) without taking due cognizance of the directions of the DRP.

13 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 4. Use of multiple year data

a. Without prejudice to the fact that CUP is the MAM, if TNMM is to applied as MAM, the Honorable DRP and the learned TPO / AO have erred in law and on facts in rejecting the use of multiple year data, without considering that the past year data had an influence on the determination of arm’s length price

a. Without prejudice to the above, the Honorable DRP and the learned AO/TPO erred in law and in facts in adopting the following filters for conducting TNMM analysis, without appreciating the TP documentation prepared by the Appellant:

• Rejection of companies whose data is not available for FY 2009-10; • Rejection of companies whose income from Manufacturing / Industrial segment is less than 75 percent of total operating revenue; • Rejection of companies having different financial year ending (other than March 31, 2010); and • Rejection of companies which have persistent operating losses.

b. The Honorable DRP and the learned AO / TPO, has erred in law and on facts, by including the following additional comparable companies without considering the detailed submissions of the Appellant:

• Fatpipe Networks India Limited; and • Smartlink Network Systems Limited

c. The Honorable DRP has erred in law and on facts in not providing any directions on VXL Instruments Limited and WEP Peripherals Limited despite the fact that the said companies was mentioned to be comparable by the learned TPO in the TP order but was not included in the final set of comparable companies

a. The Honorable DRP has erred in law and on facts in upholding the learned AO / TPOs stand in treating the provision of doubtful debts as non-operating in nature thereby wrongly computing the operating margin of the comparable companies after excluding the provision for doubtful debts.

b. The Honorable DRP has erred in law and on facts in upholding the learned AO / TPOs stand in not excluding an exceptional item of expense amounting to Rs 97,011,754 thereby wrongly computing the operating margin of the Appellant.

14 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 7. Risk adjustment

a. Without prejudice to the fact that CUP is MAM, theHonorable DRP and learned AO / TPO has erred in not granting risk adjustment based on comparability adjustments while adjudicating the matter at TNMM

a. The DRP and the learned AO have erred in law in arbitrarily disallowing the provision for warranty amounting to Rs 28,87,73,978 claimed as a deduction by Lenovo (India) Private Limited (“Lenovo India” or the “Appellant”).

b. The Honorable DRP and the learned AO have not appreciated the fact that Lenovo Indiamaintains its books on a mercantile basis of accounting and that the said warranty provision has been created on a scientific manner followed consistently over the years, having due regard to the nature of activity, its global warranty accrual processes and the industry requirement in which the Appellant operates.

c. The Honorable DRP and the learned AO haveerred on facts in failing to consider that Lenovo India has provided for warranty on a scientific and consistent manner every year applying the principles laid out by the Honourable Supreme Court in the case of Rotork Controls India Private Limited3 and therefore such expenditure is an allowable deduction under section 37 of the Act.

d. The learned AO has erred in not appreciating the fact that warranty provision created for AY 2008-09 and AY 2009-10 was accepted to be created on a scientific basis by the learned AO after examining the same and allowed as a deduction under section 37 of the Act.

e. The Learned AO has erred in appreciating that Lenovo India provides warranty for a period from one year to three years on its products and accordingly, the entire provision could not be utilized in one year and has to be spread over multiple years.

The Appellant further craves to adjudicate upon the following grounds for the first time before the Honourable ITAT which were not raised before the DRP. These grounds are purely legal grounds requiring no further examination of facts and therefore, it is humbly prayed that these grounds be admitted based on the decision of Honourable Supreme Court in the case of National Thermal Power Corporation – 229 ITR 383.

9.1 The learned AO has erred in law and on facts in holding that the warranty provision of Rs 28,87,73,978 and provision for leave encashment amounting to Rs 19,05,538 are

15 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 unascertained liabilities and not appreciating that the provisions have been created as per the provisions of the relevant accounting standards / principles which is consistently followed by the Assessee year on year.

9.2 The learned AO has erred in law by treating the provisions as unascertained liabilities and adding it back to the book profits under section 115JB of the Act without providing an opportunity of being heard during the assessment proceedings.

9.3 Without prejudice to the above ground that the provision for leave encashment is not an unascertained liability, the learned AO has erred in disallowing Rs 19,05,538, without appreciating the fact that no additional provision was created during the year and that the closing balance of provision for leave encashment vis-à-vis the opening balance has reduced by Rs 1,94,659.

It is humbly requested that the above grounds raised for the first time before the HonourableITAT be allowed to be adjudicated upon otherwise the appellant shall suffer irreparable loss. 10. The learned AO has erred on facts by incorrectly calculating the amount of brought forward book loss and brought forward depreciation under section 115JB of the Act. The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds, at any time before or at the time of hearing of the appeal. Each of the above objections is independent and without prejudice to the other grounds preferred by the Appellant.”

adjudication.

accepted the objections of the assessee regarding the CUP as MAM instead of

TNMM adopted by the TPO. However the TPO/A.O. while passing the final order

in pursuant to the directions of the DRP have not given effect to the directions on

this issue. He has further contended that the DRP has decided this issue in detail

16 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 and passed directions in para 4.6 but the TPO/Assessing Officer has not followed

the directions of the DRP while passing the final order. Consequently, the

assessee filed a petition under Section 154 of the Act which was also dismissed by

the TPO/A.O. Thus the assessee has also filed a separate appeal against the

order passed under Section 154. The ld. Senior Counsel for the assessee has

pointed out that for the Assessment Years 2007-08 as well as 2008-09, the

Tribunal has decided an identical issue in favour of the assessee. Therefore the

issue is otherwise covered in favour of the assessee.

submitted that while passing the directions, the DRP has not properly understood

the directions of the Tribunal for the Assessment Year 2007-08 and therefore the

TPO/A.O. has given the reasons for not following the directions of the DRP. Thus

the learned Departmental Representative has submitted that when the DRP has

passed incorrect directions, the TPO/A.O. has rightly not followed the same.

on record. It is pertinent to note that an appeal before the Tribunal lies only when

the final order is passed to frame the assessment in pursuant to the directions of

the DRP. Therefore before the final order is passed no appeal lies against the

directions of the DRP. It is also undisputed proposition of law as per the

17 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 provisions of section 144C that directions of the DRP are binding on the TPO/A.O.

Therefore the cause of action to file the appeal arises only after passing order

framing assessment is passed in pursuant to the directions of the DRP. If the final

order is not against or prejudicial to the interest of revenue then the revenue

would have no grievance against the final order as well as the directions of the

DRP. Even otherwise, the interest of revenue depends upon the demand raised

by the Assessing Officer as per the final order to frame the assessment in

pursuant to the directions of the DRP. Thus once the TPO/A.O. has not passed

the final order in pursuant to the directions of the DRP, the revenue has no cause

of action and consequently has no right to file the appeal against such order as

well as directions of the DRP. When the directions of DRP is binding then the

TPO/A.O. is bound to give the effect to the directions of DRP irrespective of the

fact whether the same are acceptable or not to the department. The remedy

against the directions is available to the department to file the appeal but only

when a final order is passed in pursuant to the directions of the DRP. This

conduct of the TPO/A.O. is otherwise a clear defiance and disregard to the

binding directions of the higher authorities.

the DRP did not understood the order of the Tribunal in correct prospective, we

18 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 are of the view that even if the directions of the DRP are not acceptable to the

department and may be contrary to the precedent, the remedy is only to

challenge the same in the appeal and not to refuse to give effect the same.

However we find that the DRP has duly considered this issue in paras 4.5 & 4.6 as

under :

19 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011

20 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011

21 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011

22 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011

Thus it is clear that the DRP has taken an independent view and not merely

followed the decision of this Tribunal. The reference of the decision of this

Tribunal has been made only to fortify the finding of the DRP. We further note

that the Tribunal in assessee's own case for the Assessment Years 2007-08 &

2008-09 while dealing with an identical issue vide order dt.30.05.2015 has held in

para 7 as under :

“ 07. Thereafter on 30.01.2014, TPO had passed a fresh order u/s.92CA of the Act, purportedly to comply with the directions of the Tribunal. In the said order, TPO stated that assessee had relied on RPM method for A. Ys. 2007-08 and 2008-09, whereas in the assessment for these assessment years TNMM was adopted by the Revenue. Thus as per the TPO, TP analysis of the assessee could not be considered as accepted for A. Ys. 2007-08 and 2008-09. Taking this view, TPO chose not to make any change to its original order dt.28.09.2010. Assessee had thereafter moved an application before the DRP which held as under at paras 2.2 to 2.4 of its order dt.29.12.2014 :

2.2 In giving effect to the above directions the TPO has mentioned that in both AY 2007-08 and 2008-09, the respective TPOs had not accepted the CUP methodology followed by the tax payer in its TP analysis as the Most Appropriate Method (MAM). After rejecting the CUP as MAM the TPOs in both the years proceeded to conduct separate analysis following the Transaction Net Margin Method (TNMM) as MAM. The result of this independent analysis by the TPO was that in both the manufacturing and trading segment the TPO found that the tax payer's profit margin was higher than the TPO's analyzed margin, and, hence no adjustment was called for. The fact that the TPOs in both the years had rejected the CUP as MAM and applied TNMM was taken by the AO, while giving effect to the ITAT's direction, to indicate that those TPOs had not accepted the TP analysis of the assessee in AY 2007-08 & 2008-09. It was, therefore, concluded that the tax payer's claims made before the Hon'ble ITAT were incorrect to the extent that a TP analysis of the assessee was accepted by the TPO in both the years.

2.3 In its objections the tax payer has grieved that although the TPO in AY 2007-08 and AY 2008-09 had sent show causes proposing to reject the CUP method and apply TNMM, the tax payer in both the

23 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 years had replied by giving detailed justification for its belief that CUP was the most appropriate method Thereafter, the purported independent analysis carried out by the TPO under TNMM in both the years was never communicated to the tax payer. During the set aside proceedings also, the present AO has not made available this analysis to the tax payer. The tax payer, therefore, had no reason to believe that subsequent to its reply to the show causes, the TPOs had not accepted its contentions about CUP being MAM and TNMM having been applied.

2.4 The objections as above are found to carry merit. The directions of the Hon'ble Tribunal was in respect of "transactions of the assessee". It was not in respect of the most appropriate method applied for analysis of the transactions for purposes of determining Arm's Length Price (ALP). The TPO has proceeded in his impugned order down the second path i.e. with regard to MAM. This was clearly not his mandate. As far as the transaction in question was concerned, the conclusion of the TPOs in both AYs 2007-08 and 2008-09 was that the relevant transactions were at Arm's length. This is the verification which was expected by the Hon'ble ITAT. The objections of the tax payer are found to be in order and the TPO's reiteration of the position adopted in his original order dt. 28.09.2010 is inappropriate.

However, a reading of the final assessment order passed by the AO on 30.01.2015 show that TPO had pursuant to the DRP directions passed an order dt.29.01.2015 not complying with the directions of the DRP. AO had therefore persisted with the same adjustment that he had done earlier. Section 144C which dwells on the powers of the DRP, states as under at sub-section (10):

144C(10) : Every direction issued by the Dispute Resolution Panel shall be binding on the Assessing Officer.”

In view of the above discussion as well as the decision of this Tribunal in

assessee's own case, we delete the addition made by the TPO/A.O. on account of

transfer pricing adjustment.

finding in respect of Ground No.4 of assessee's appeal for the A.Y. 2007-08, these

grounds of the assessee's appeal become infructuous and being consequential.

relevant material on record. This issue is identical as involved in the assessee's

24 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 own case for the Assessment Year 2007-08, in view of our finding on this issue for

the Assessment Year 2007-08, this ground stands allowed.

as leave encashment while computing the book profit under Section 115JB of the

Act.

relevant material on record. As regards the adjustment on account of warranty

provision while computing the book profit under Section 115JB of the Act, in view

of our finding on the issue of allowability of warranty provision the same cannot

be treated as uncertain liability/provision. As regards the provision for leave

encashment though the said claim was not allowable in view of the provision of

Section 43B however in view of the decision of Hon'ble Supreme Court in the case

of BEML 245 ITR 421, this is a certain liability though payable in future we

further note that the Tribunal in assessee's own case for the Assessment Year

2011-12 has considered and decided this issue vide order dt.21.10.2016 in paras

11 & 12 as under : “ 11. Ground No.3 relates to addition of provision for gratuity, leave encashment and warranty to book profits. The AO added provision for warranty, gratuity and leave encashment on the ground that these provisions are unascertained liabilities. The Hon’ble DRP also confirmed the same. 11.1 Before us, learned counsel for the assessee submitted that provision for gratuity was allowed as deduction in the proceedings u/s 154 of the Act and therefore, not pressed. As regards provision for leave encashment, he submitted

25 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 that it is not a contingent provision and is allowable as deduction in view of the decision of the Hon’ble Supreme Court in the case of Bharat Earth Movers vs. CIT (supra). As regards provision for warranty, learned counsel for the assessee submitted that since same is allowable as business expenditure, it cannot be added to book profits. 11.2 On the other hand, ld.CIT(DR) placed reliance on the orders of the lower authorities. 12. The only issue relates to addition of provision for leave encashment and the provision for warranty expenditure added to book profits while computing tax liability u/s 115JB of the Act. As regards provision for warranty expenditure, we had already held that it is not a contingent liability and hence is allowable as deduction. Therefore, the question of addition to book profits does not arise. As regards provision for leave encashment, following the decision of the Hon’ble Gujarat High Court in the case of DCIT vs. Inox Leisure Ltd. (351 ITR 314), the same is allowable as deduction. The Hon’ble Gujarat High Court, after considering the decision of the Hon’ble Apex Court in the case of Bharat Earth Movers (supra) held as follows: “16. Coming to the question No. 2, we notice that the same arises out of the Tribunal's decision to uphold the CIT(A)'s view that the provision of Rs. 5,10,000/- made by the assessee towards its gratuity liability cannot be added back for the purpose of computation of the assessee's income under Section 115JB of the Act. Section 115JB of the Act as is well known pertains to special provision for payment of tax by certain companies. Sub-section (1) of Section 115JB of the Act provides that a minimum alternative tax to be paid by the companies as computed under the said provision. Sub-section (2) of Section 115 JB requires every company for the purposes of the said section to prepare its profit and loss account in accordance with the provisions of paras 2 and 3 of Schedule 6 of the Companies Act. Explanation 1 to said section provides that for the purposes of the said section, "book profit" means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by various items specified in Clauses (a) to (i) provided therein. Clause (c) thereof reads as thus: "(c) The amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities;" In other words, if an amount is specified for provision which is for meeting with the liabilities not ascertained such provision so made shall have to be added back to the book profit of the company. Put it differently, if such provision is made for ascertained liability, no such addition back shall be made. In this context, the Tribunal was called upon to decide whether the assessee having made provision of Rs. 5,10,000/- towards gratuity would be covered under Clause (c) to Explanation 1 to Section 115JB of the Act. The

26 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 Tribunal relied on the decision of the Bombay High Court in case of CIT v. Echjay Forgings (P.) Ltd. [2001] 251 ITR 15/116 Taxman 322 and confirmed the view of the CIT(A). 17. Having heard learned counsel for the parties and having perused documents on record, we notice that CIT(A) as well as the Tribunal both noted that such provision for payment of gratuity was made on the basis of actuarial valuation method to this aspect. The revenue has not been able to make any dispute. If we proceed on that basis, law to our mind, seems fairly well settled. Bombay High Court in case of Echjay Forgings (P.) Ltd (supra) in the context of similar provisions made in Section 115JB of the Act examined whether the provision of gratuity liability of a company is required to added back to its book profit. In this context, it was held that the assessee had made the provision for gratuity on the basis of actuarial calculations. He, therefore, cannot be said that the provision for gratuity is not ascertained liability. 18. In case of Bharat Earth Movers v. CIT [2000] 245 ITR 428/112 Taxman 61 the Apex Court held that the amounts set apart by an assessee to meet its liability on account of leave encashment of employees is not a contingent liability. It was observed that what should be certain is the incurring of the liability which should also be estimated with reasonable certainty though the actual quantification may not be possible then. Its requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. 19. Likewise in case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC), the Apex Court examined the question whether it is legitimate in such a scheme of gratuity to estimate the liability on an actuarial valuation and deduct the same in profit and loss account while working out the net profit of a company and further whether such appropriation amounts to a reserve or provision. The Supreme Court held that an assessee can while working out its net profits, provide from its gross receipts his liability to pay a certain sum towards gratuity liabilities of the employees. If such liability is properly ascertainable and it is possible to arrive at proper discounted present value. 20. In case of Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62/180 Taxman 422 (SC), the Supreme Court in the context of an assessee making provision for estimated expenditure towards warranty observed that provision is a liability which can be measured only by using substantial degree of estimation. Such provision is recognized when an assessee had a present obligation as a result of past events, and it is possible that any outflow of resources will be required to settle the obligation and further a reliable estimate can be made of the amount of obligation.

27 IT(TP)A Nos.511, 580 & 581/Bang/2015 & 1307/Bang/2011 21. Considering the above judicial pronouncements and the facts on hand, we have no hesitation in upholding the Tribunal's view that though actual payment of gratuity may be made at a later point of time upon periodical release of the employees from service, it is provision having been made on actuarial basis it cannot be stated to be an uncertained liability so as to add it back in terms of Clause (c) to Explanation 1 to Section 115JB. ” Respectfully following the above decision, we hold that provision for leave encashment need not be added back to book profits for the purpose of determining tax liability u/s 115JB of the Act.”

Following the earlier order of this Tribunal in assessee's own case, we decide this

ground in favour of the assessee and delete the addition made by the Assessing

Officer on account of these two amounts while computing the book profit.

infructuous in view of our finding on this issue in the main appeal.

reasoning as discussed while deciding this issue in assessee's appeal.

as 2010-11 are allowed and assessee's appeal against the order under Section 154

and revenue’s appeal for the A.Y. 2010-11 are dismissed.

Order pronounced in the open court on the 31st day of Mar.,2017. Sd/- Sd/- (S. JAYARAMAN) (VIJAY PAL RAO) Accountant Member Judicial Member Bangalore, Dt.31.03.2017. *Reddy gp