Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, BANGALORE BENCH A, BANGALORE
Before: SHRI. ABRAHAM P. GEORGE & SHRI. VIJAY PAL RAO
IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCH 'A', BANGALORE BEFORE SHRI. ABRAHAM P. GEORGE, ACCOUNTANT MEMBER AND SHRI. VIJAY PAL RAO, JUDICIAL MEMBER I.T(TP).A No.582/Bang/2015 (Assessment Year : 2006-07) Lenovo (India) P. Ltd, Ferns Icon, Level 2, Doddenaundi Village, Marathahalli Outer Ring Road, K.R. Puram Hobli, Bengaluru 560 037 .. Appellant PAN : AABCi3372H v. Deputy Commissioner of Income-tax, Circle -4(1)(1), Bengaluru .. Respondent Assessee by : Shri. Padamchand Khincha, CA Revenue by : Shri. P. Chandrashekar, CIT Heard on : 19.05.2016 Pronounced on : 30.05.2016 O R D E R PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER :
In this appeal filed by the assessee it has altogether taken seven grounds of which ground 1 is general in nature, needing no specific adjudication.
IT(TP)A.582/Bang/2015 Page - 2
Vide grounds 2 to 6 grievance raised by the assessee is on a TP adjustment recommended by the TPO. Ld. Counsel for the assessee submitted that this was the second round of proceedings before this Tribunal. As per the Ld. AR issue regarding the adjustments made on the pricing of the international transactions of the assessee with its AEs was a subject matter before this Tribunal in an appeal filed by the assessee in ITA No.1457/Bang/2010. As per the Ld. AR, vide its order dt.16.03.2012, Tribunal had given clear directions to the TPO to verify whether similar transactions entered by the assessee with its AEs for previous years relevant to A. Ys. 2007-08 and 2008-09, were accepted by the TPO in such years. As per the Ld. AR, Tribunal had directed the AO to accept the pricing of thee international transaction of the assessee for the impugned year to be at arms length, if similar transactions with AEs were accepted by the TPO to be at arms length for previous years relevant to A. Ys. 2007-08 and 2008-09.
Continuing his submissions, Ld. AR pointed out to the consequential order passed by the TPO, on 30.01.2014 wherein TPO mentioned that TP analysis done by the assessee for A. Y.s.2007-08 and 2008-09, were not accepted. As per the TPO in such earlier years, assessee had applied CUP IT(TP)A.582/Bang/2015 Page - 3 method for analysing the pricing of the international transactions, whereas TPO had gone by TNMM. According to the Ld. AR, based on this erroneous persisted with the original recommendations made by him.
Ld. AR submitted that further to the TP order mentioned above, and based on a draft assessment proposed by the AO, assessee had once again moved in appeal before the DRP. As per the Ld. AR, DRP vide its order dt.29.12.2014 had accepted the stand of the assessee. However, as per the Ld. AR, despite directions of the DRP, TPO vide order passed on 29.01.2015 persisted with his earlier recommendation and pursuant to such TP order assessment was completed without bypassing the DRP order. Hence according to Ld. AR, the adjustment recommended by the TPO / AO was to be set aside.
Per contra, Ld. DR submitted that the AO was bound by the order passed by the TPO u/s.92CA(4) of the Act, and hence AO could not be faulted for following the directions of the TPO.
We have perused the materials and heard the rival contentions. Directions given by the Tribunal in the earlier round of proceedings as it appears at para 12 of its order is reproduced hereunder :
IT(TP)A.582/Bang/2015 Page - 4
Having heard both the parties and having considered the rival contentions and the material on record, we find that the assessee has followed the internal CUP method for arriving at ALP for the import of raw material, where as the TPO, in his order, has mentioned that the assessee has adopted the external CUP method. Similarly, for the royalty payment, the assessee has adopted the external cup method and it was a single payment, whereas the TPO observed at page 21 of his order that it is recurring payment. There were many flaws in the TPO's order which demonstrate that the facts of the case have not been properly appreciated by the TPO while making the IP study analysis. Another fact worth noting is that the similar transaction with the associated enterprises for the subsequent years have been considered by the TPO and have been accepted without any ALP adjustments. There has to be a continuity and uniformity in the approach the Revenue towards an issue and particularly in the case of the same assessee. In the case of the assessee before us, the adjustments have been made only for the relevant assessment year, whereas similar transactions have been accepted to be at ALP for the subsequent years even though the same method has been followed by the assessee. When the facts and circumstances are exactly the same, the Revenue cannot be permitted to take a different approach in two different assessment years. In view of the same, we deem it and proper to remit this issue of TP study to the file of the assessing authority with a direction to verify as to whether the similar transactions of the assessee with associated enterprises have been accepted by the TPO for the assessment year 2007-08 and 2008-09 and if it is found to be true, then the AO is directed to adopt the TP analysis conducted by the assessee for the relevant assessment year also to be at ALP and make the assessment accordingly. These grounds are accordingly allowed for statistical purposes. 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.
IT(TP)A.582/Bang/2015 Page - 5 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 IT(TP)A.582/Bang/2015 Page - 6
TNMM, the tax payer in both the 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):
IT(TP)A.582/Bang/2015 Page - 7 144C(10) : Every direction issued by the Dispute Resolution Panel shall be binding on the Assessing Officer.
It is clear that the directions of the DRP is binding on the AO. No doubt as per Section 92CA(4) of the Act, an AO has to compute total income in conformity with the arms length price determined by the TPO. However, once there is an order of DRP, AO is bound by the directions of the DRP by virtue of sub-section (1) to Section 144C of the Act. AO is not required to refer the matter which has been decided by the DRP to the TPO again. We are therefore of the opinion that the addition made by the AO without considering the directions of the DRP reproduced by us above cannot stand in the face of the clear legal mandate. We delete such additions. Grounds 2 to 6 of the assessee is treated as partly allowed.
Vide its ground 7, grievance of the assessee is on disallowance of warranty provision of Rs.42,19,22,899/-. Directions of the Tribunal with respect to the provision for warranty in the earlier round of proceedings, which appear at paras 19 and 20 of its order dt.15.03.2012, is reproduced hereunder :
Having heard both the parties and having considered the rival contentions, we find that the Hon’ble Supreme Court in the case of Rotork Controls Ind. Pvt. Ltd., (cited Supra) has held that when a product is sold with a warranty provision, it cannot IT(TP)A.582/Bang/2015 Page - 8 be held that the assessee has no obligation for the said warranty but for making a provision for the said warranty a reliable estimate should be made on the amount of obligation and a scientific method should be used. In the said decision, it was held that a provision is a liability which can be measured only by using substantial degree of estimation and it is recognized when – a) an enterprise has a present obligation as a result of a past event; b) It is probable that an out-flow of resources will be required to settle the obligation; and c) A reliable estimate can be made on the amount of the obligation.
In the case before us, the assessee has acquired the business of desk tops and lap tops from IBM in the financial year relevant to the assessment year 2006-07. This being the first year of its business in personal computers, it has no data relating to the probable expenditure it would have to meet on account of warranty provision. It is also not disputed that IBM was carrying on business in India in the earlier assessment years and IBM was making the provision for warranty on the basis of its global data. Therefore, it cannot be said that the assessee cannot use the data used by IBM for the past year for making the estimation. If the assessee has made the provision on a scientific basis, it has to be allowed as deduction. However, this fact as to whether the assessee has made the provision in a scientific method has to be verified by the assessing authority. In view of the same, we deem it fit and proper to remand this issue to the assessing authority to reconsider the issue afresh in the light of the guidelines issued by the Hon’ble Supreme Court in the case of Rotrack Controls India Pvt. Ltd (cited Supra) and other judicial precedents. This ground is accordingly allowed for statistical purposes.
IT(TP)A.582/Bang/2015 Page - 9
Pursuant to the above proceedings, AO had considered the question of of warranty provisioning once again. Assessee there upon submitted a letter dt.06.03.2014 to the AO wherein it gave the methodology for warranty provisioning. As per the assessee, warranty obligations were worked out based on the number of laptops and desktops sold by it, which carried a warranty obligation as on 31st March every year. Assessee also gave the details of the work out. As per the assessee it was considering the unexplained warranty period in respect of each machine which was sold and multiplying it by the repair rate and cost per claim. As per the assessee, repair action rate was a percentage of the claims out of the total sales based on historical data. Similarly cost per claim was the average of cost based on historical global data. Assessee pointed out that relevant previous year was the first year of operation of the assessee, having taken over the PC business of IBM as a going-concern basis. In other words assessee argued that provision for warranty was based on historical data and principles adopted by IBM for making similar provision. Assessee also gave a perspective of the expenditure incurred on warranties for assessment years up to A. Y. 2009-10. As per the assessee, such expenditure was increasing, and the provisioning was justified.
IT(TP)A.582/Bang/2015 Page - 10
However, AO did not find the above contentions acceptable. According to him, percentage of utilisation for warranty provision made by the assessee in the impugned assessment year as well as subsequent assessment years proved that only about 22% of such provisions were utilised. According to the AO there was a great mismatch between the provision created and the actual expenditure. He made a correlative study of the actual warranty spending with the warranty provision for F. Ys. 2005-06 to 2009-10. According to him, there was an increase of sales turnover from Rs.1044 crores in F . Y. 2005-06 to Rs.1805 crores in F. Y. 2007-08 whereas and there was a drop in turnover to Rs.1286 crores in F. Y. 2008-09, though it marginally increased to Rs.1,329 crores in F. Y. 2009-10. As per the AO, there was no proportion between the warranty and the turnover. AO also noted that warranty provision utilised were always lesser than the provision created. Thus according to the AO, assessee could not show any scientific methodology adopted for estimating the provision of warranty. Therefore, he allowed the actual warranty expenditure of Rs.7.66 crores and made a disallowance of the balance claim. Such disallowance came to Rs.27,27,96,488/-.
IT(TP)A.582/Bang/2015 Page - 11
12. Though the assessee assailed the above addition proposed by the AO before the DRP, it did not meet with any success. As per the DRP, analysis done by the AO was rational and fair and no evidence or technical studies disclosing the past trends of sale and its relation with warranty provisioning was produced by the assessee.
Now before us, Ld. AR strongly assailing the orders of the lower authorities submitted that it was the first year in which the assessee was selling desktops and laptop computers. As per the Ld. AR such business was taken over by the assessee from IBM. Ld. AR pointed out that assessee was therefore forced to fall back upon the data archived by IBM with regard to warranty provision. As per the Ld. AR, assessee had filed a letter on 25.05.2012 before the AO wherein the computation of warranty provision was clearly given. Relying on paper book page 33, Ld. AR submitted that there was a specific formula submitted by the assessee for working out the warranty provision required for desktops and laptops manufactured and traded by it. Assessee had adopted the repair percentage rate followed at Asia Pacific level by IBM. Assessee had also taken the cost claim as per the Asia Pacific level of IBM. There was no finding by any of the lower authorities that the repair percentage or cost per claim which were the basic building blocks of the warranty provision IT(TP)A.582/Bang/2015 Page - 12 were estimated without scientific basis or without sufficient back-up data. Lower authorities had not considered this, but simply went by a turnover ratio. As per the Ld. AR, even if relations between actual warranty expenditure and warranty provisioning were to be reckoned, assessee was still on a safe wicket. As per Ld. AR, financial year 2005-06 was the first year in which assessee was doing a business of desktops and laptops. It was due to this reason that the provisioning for that year was much higher than what was incurred for warranty repairs. As per the Ld. AR provision made on 31.03.2006 ought to be compared with actual spendings for F. Y. 2006-07. If that was considered, Ld. AR submitted that spending of the assessee on warranty were much higher than the provisioning made. Thus according to him warranty provisioning was done by the assessee on a scientific basis and the disallowance was unjustified.
Per contra, Ld. DR submitted that assessee had relied on data pertaining to IBM for arguing that it was following scientific method. But how it had arrived at the repair rate or cost per claim from historical data of IBM was never brought before the lower authorities. Assessee had simply produced certain figures and relied on it without any back-up data. As per the Ld. DR, Hon’ble Supreme Court in the case of Rotork Controls India (Pvt) Ltd vs CIT [(2009) 314 ITR 62] specifically stipulated that an assessee should prove the scientific IT(TP)A.582/Bang/2015 Page - 13 method followed by it for provisioning and it was the onus of the assessee to produce historical data to prove such method. Having not done that, as per the Ld. DR, it could not be said that assessee was following a scientific method. Thus according to him, lower authorities were justified in disallowing the claim of warranty provision to the extent it went beyond actual warranty expenditure.
Ad libitum reply of the Ld. AR was that assessee was mandatorily required to follow AS-I and II, w.e.f. 25.01.1996 by virtue of Notification No.9949, dt.25.01.1996. As per the Ld. AR, AS-I required provisioning to be made for all known liabilities and losses, even though the amount represented only a best estimate in the light of available information. As per the Ld. AR judgment of Hon’ble Supreme Court in the case of Rotork Controls India (Pvt) Ltd was for A. Ys. 1994-95 to 1996-97 when it was not required to follow AS-I mandatorily. Thus once the notification dt.25.01.1996 came into operation, a scientific estimate could be made considering the past data for availing of the deduction. As per the Ld. AR, this is what assessee had done. Reliance was also placed on judgment of Hon’ble Delhi High Court in the case of CIT v. Ericssion Communications P. Ltd [(2009) 318 ITR 340]. Relying on the judgment of Hon’ble Apex Court in the case of Commissioner of Sales-tax v. M/s. H. M. Esufall [(1973) AIR 2266] Ld AR submitted that an estimate could IT(TP)A.582/Bang/2015 Page - 14 be an over estimate or under estimate and there would always be an element of guess work while making an estimate. This, as per the Ld. AR, was not a reason to reject a legitimate claim of the assessee.
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 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 :
IT(TP)A.582/Bang/2015 Page - 15 IT(TP)A.582/Bang/2015 Page - 16 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 IT(TP)A.582/Bang/2015 Page - 17 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.
In the result, appeal of the assessee is allowed.
Order pronounced in the open court on 30th day of May, 2016.