WINERGY DRIVE SYSTEMS INDIA PRIVATE LIMITED,MUMBAI vs. ACIT, CHENNAI

आयकर अपील�य अ�धकरण, “डी” �यायपीठ, चे�नई IN THE INCOME-TAX APPELLATE TRIBUNAL ‘D’ BENCH, CHENNAI �ी चं� पूजार�, लेखा सद�य एवं �ी धु�वु� आर.एल रे�डी, �या�यक सद�य के सम� Before Shri Chandra Poojari, Accountant Member & Shri Duvvuru RL Reddy, Judicial Member आयकर अपील सं./I.T.A.No.1720/Mds/2014 �नधा�रण वष�/Assessment Year:2008-09 M/s. Winergy Drive Systems India The Assistant Commissioner of Private Limited (Merged with Vs. Income Tax, Siemens Ltd.), Corporate Taxation, Company Circle III(3), 3rd Floor, 130 Pandurang Budhkar Chennai . Marg, Worli, Mumbai 400 018. [PAN: AAACW5466B] (अपीलाथ� /Appellant) (��यथ�/Respondent) अपीलाथ� क� ओर से / Appellant by : Shri Raghunathan Sampath, Advocate ��यथ� क� ओर से/Respondent by : Shri Milind Madhukar Bhusari, CIT सुनवाई क� तार�ख/ Date of hearing : 05.04.2016 घोषणा क� तार�ख /Date of Pronouncement : 30.06.2016 आदेश /O R D E R PER DUVVURU RL REDDY, JUDICIAL MEMBER:

This appeal filed by the assessee is directed against the order of the ld. Commissioner of Income Tax (Appeals) III, Chennai, dated 03.02.2014 relevant to the assessment year 2008-09 passed consequent to the order of the Assessing Officer under section 143(3) r.w.s. 144C(3) of the Income Tax Act, 1961 [“Act” in short] dated 20.02.2012.

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2.1 The facts of the case are that during the previous year ended 31.03.2006, the assessee contracted a loan in Euros [which was classified in the financials as External Commercial Borrowings] from its parent Winergy AG. The said loan was to be repaid in 12 half yearly instalments commencing from September, 2007. Perusal of the copy of Intra Group Loan Agreement filed by the assessee shows that the loan was availed in Euros and the maximum amount of principal was 48,50,000 Euros. The assessee has to pay interest at a rate equal to Euribor rate plus 1.75% for each interest period. Taking into account the margin of 1.75%~ the effective interest rate charged varied from 3.603% to 6.536%. Applying CUP method, treating itself as the tested party, assessee identified 3 comparables for benchmarking the transaction of payment of interest on ECB and claimed that the payment of interest is at arm's length. The TPO in his order made out the following inconsistencies in the comparables chosen by the assessee for benchmarking the transaction. (a) The interest on ECB paid by the comparables was linked to Libor whereas the assessee's service of interest relates to Euribor. (b) The assessee contended that the effective interest rate on ECB in the case of comparables was Libor plus 1.54% which translates to 6.02%. In one of the comparables viz., Bharat Gears Ltd identified by the assessee, the rate of interest was

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taken to be Libor plus 3 to 5%.The assessee adopted the average of 4% and computed the effective rate of interest of the comparables. The said approach of averaging cannot effectively convey the actual rate of interest of comparables. The actual interest rate should have been computed with reference to the interest burden and the loan outstanding for the various periods. (c) Besides, in support of its claim of interest charged in the case of comparables, the assessee did not adduce any documentary evidence viz., the downloaded financials of the comparables, despite being specifically asked to do so as evident from the order sheet notings. Therefore the said claim was found to be unsubstantiated as the appellant failed to discharge its onus. 2.2 In the light of the assessee's claim found to be unsubstantiated, the TPO relied upon a document which is prepared by the Department of Economic Affairs, Ministry of Finance, Government of India titled as ‘India's External Debt - Status Report - 2008'. Page 29 of the said document furnishes the details of loans contracted during the financial year 2007-08 in various currencies like US dollar, Euro, GB Pound and Japanese Yen. It lists out the range of libor rates and the effective interest rate on ECBs including all in cost. Taking this as the source document, the TPO identified the effective interest rate on ECBs at 4.81% including all in cost and worked out the downward adjustment as mentioned in the Order.

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Debt. The implicit interest rate on India's total external debt is estimated by taking interest payments during the year as a percentage of the outstanding debt at the end of the financial year. For the period corresponding to the relevant previous year, the implicit rate of interest was mentioned as 7.5%. The assessee relies upon this rate and contends that the rate of interest taken into account by TPO of 4.81 % is not correct as there is contradiction in the report. The data referred to in Page 15 is not with reference to interest rate on any loan in any specific currency like US dollars, Euros etc., but shows interest rate calculated as a percentage using the following formula.

The total interest payment during the year 2007-08 X 100 Outstanding debt at the end of 31.3.2008 Therefore, the ld. CIT(A) has observed that the said document cannot help the assessee to assail the approach of the TPO, who relied upon a sovereign document with reference to specific currency in which the loan was contracted by the assessee. Therefore the TPO's approach needs to be upheld. • The appellant failed to discharge its onus by failing to substantiate its claim of interest paid by comparables by furnishing the down loaded financials. • The document relied upon by the TPO has direct evidentiary value. • The apprehension of the appellant that the facts in the said document are inconsistent as compared to the data in the Status Report for FY 2010-11 is not correct as the data refers to the implicit rate of interest expressed as percentage on the total debt outstanding during the FY.

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3.1 Further, the ld. CIT(A) has stated that the assessee was furnished copy of the remand report submitted by the TPO to state its case. In response thereto, the assessee filed written submissions dated 11/12/2013. The assessee claimed that the loan transaction with AE attracted interest applicable on three months Euribor rates, whereas the TPO adopted an average rate without reference to the time period. Besides, the TPO did not take into account the adjustments that would be called for on account of various factors that would be relevant for consideration while funds are advanced to a party like credit rating, term of the loans, collaterals, fixed vs floating rates, risk free rate and premium and underlying Euribor rates.

3.2 The ld. CIT(A) duly considered the submissions as admitted by the assessee itself, during the relevant previous year the rate of interest paid by the assessee was as under: First Quarter 5.472% Second quarter 5.664% Third quarter 5.914% Fourth quarter 6.536% Average: 5.8965% [The above rates are inclusive of base rates plus margin] The ld. CIT(A) has observed that the assessee failed to address the inadequacies pointed out in the remand report of the TPO in respect of the computation of interest rate applicable in the case of comparables. Instead the appellant tried to place more reliance on the multiple Euribor rates possible and

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the various factors that need to be considered in a transaction of this type. Primarily the onus rests on the assessee to place all the facts on record and to furnish complete information in support of its claim that the transactions are at arm's length. In fact the copy of the agreement entered into shows that the borrower (appellant) shall pay interest on the last banking date of each interest period at a rate equal to the Euribor rate for such interest period plus 1.75%. The agreement does not specifically state that the Euribor interest rate is either 3 months rate or 6 months rate. In respect of the comparables chosen by the assessee for benchmarking, all the relevant data was not made available. In the absence of the same, the TPO is left with no option but to apply the Euribor interest rate applicable in general for the relevant financial year. Under these circumstances, the ld. CIT(A) has held that the approach adopted by the TPO calls for no interference and thus the order of the TPO which has been incorporated in the assessment order is upheld and grounds 8 to15 are dismissed by the ld. CIT(A).

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interest period, which worked from 3.603 to 6.536/-. Though the assessee has given 3 comparables for benchmark in the interest rate on ECB loan, the Assessing Officer rejected it on the reason that interest paid by the comparables was linked to Libor because the assessee made the payment of interest rate at Euribor. Finally, the Assessing Officer applied the implicit interest rate on India’s External Debt during the year 2007-08 as the transactions relating to the said period. Now, the contention of the ld. AR is that the arm’s length interest rate should be taken from the country of the borrower/debtor i.e. the rate of interest to be used for benchmarking shall be rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate. For this purpose, he relied on the order of the Chennai benches of the ITAT in the case of M/s. Siva Industries & Holdings Ltd. (I.T.A. No. 2147/Mds/2010 AY 2006-07), wherein, it was held as under: “We have considered the rival submissions. A perusal of the order of the TPO clearly shows that the assessee had raised the funds by way of issuance of 0% optional convertible preferential shares. Thus it is noticed that the funds raised by the assessee company for giving the loan to India Telecom Holdings Ltd., Mauritius, which is its Associated Enterprises and which is the subsidiary company, is out of the funds of the assessee company. It is not borrowed funds. The assessee has given the loan to the Associated Enterprises in US dollars. The assessee is also receiving interest from the Associated Enterprises in Indian rupees. Once the transaction between the assessee and the Associated Enterprises is in foreign currency and the transaction is an international transaction, then the transaction would have to be looked upon by applying the commercial principles in regard to international transaction. If this is so, then the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR would come into play. In the circumstances, we are of the view that it LIBOR

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rate which has to be considered while determining the arm's length interest rate in respect of the transaction between the assessee and the Associated Enterprises. As it is noticed that the average of the LIBOR rate for 1.4.2005 to 3 1.3.2006 is 4.42% and the assessee has charged interest at 6% which is higher than the LIBOR rate, we are of the view that no addition on this count is liable to be made in the hands of the assessee. In the circumstances, the addition as made by the Assessing Officer on this count is deleted.” 5.1 Further, he submitted that the implicit interest rate on India’s external Debt followed by the Assessing Officer is an unadjusted industrial average, which cannot be considered in view of the OECD guidelines, which was considered by the Special Bench of Bangalore Benches of the Tribunal in the case of Aztec Software & Technology Services Ltd. v. ACIT 107 ITD 141 (Bang.) (SB), wherein the Tribunal has held as under: 163. The revenue has justified consideration of industrial average as comparable uncontrolled transaction. Before the Transfer Pricing Officer as also in proceedings before the Commissioner of Income-tax (Appeals) , the taxpayer had objected to adoption of average and objection is noted in para 7.13.1 (page 42) of the Commissioner of Income-tax (Appeals)'s order as under.- “As per OECD guidelines unadjusted industry averages cannot be taken to represent arms length conditions." 164. Transfer Pricing Officer could not meet above objection and gave round about answer. But objection raised on behalf of the assessee, in our view, is valid and justified and is required to be upheld. In Commentaries on International Transfer Pricing 2006 published by Price Water House Coopers in chapter "The Work of the OECD and Other Technical Considerations", it has been observed as under:- "Guidance for applying the arm's length principle The arm's length principle is usually applied by comparing the 'conditions (e.g. price or margin) of a controlled transaction with those of independent transactions. The Guidelines allow the use of inexact comparables that are 'similar' to the controlled transaction

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but not the use of 'unadjusted industry average returns'. The factors that should be considered when assessing the comparability of a transaction, include: - the specific characteristics of the property or services; - the functions that each enterprise performs, including the assets used and, most importantly, the risks undertaken; - the contractual terms - the economic circumstances of different markets, for example, different countries, wholesale versus retail; and - business strategies, for example, market penetration schemes when a price is temporarily lowered.” 5.2 In our opinion, there is a force in the argument of the ld. AR. The Assessing Officer cannot apply the implicit interest rate on India’s External Debt, which is unadjusted industrial average. As held by the Special Bench of the Bangalore Bench in the case of Aztec Software & Technology Services Ltd. v. ACIT (supra), we are of the opinion that the unadjusted interest rate in respect of India’s External Debt cannot be applied in assessee’s case. Before us, the ld. AR has raised a plea that Euribor rate as to be applied in view of the order of the Tribunal in the case of Tata Autocomp Systems Ltd. v. ACIT in I.T.A. No. 7354/Mum/11 for the assessment year 2007-08 vide order dated 30.04.2012, wherein, has held as under: “19. In the present case the AE is a German company. Eurobior rates are based on the average interest rates at which a panel of more than 50 European banks borrow funds from one another. There are different maturities, ranging from one week to one year. These rates are considered to be the most important rate in the European money market. The interest rates do provide the basis for the price and interest rates of all kinds of financial products like interest rate swaps, interest rate futures, saving account and mortgages. We find that the RBI in respect of export credit to exporters at internationally competitive rates under the scheme of pre-shipment credit in foreign currency (PCFC) and Rediscounting of Export Bills abroad (EBR),

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has permitted banks to fix the rates of interest with reference to ruling LIBOR, EURO UBOR or EURIBOR, wherever applicable and thereto appropriate percentage ranging from 1% to 2%. The reference to the said circular is at page - 80 of the Assessee's paper book. In our view the claim of the Assessee to adopt EURIBOR rate as stated before the TPO is reasonable and deserves to be accepted. Following the ruling of the tribunal in the aforesaid cases, we are of the view that the claim made by the assessee in this regard has to be accepted. The AO is directed to work out the TP adjustment accordingly. Gr.No.l to 4 are thus partly allowed.” 5.3 However, before the lower authorities, the assessee has furnished 3 comparables for ascertaining arm’s length interest rate, which is linked to Libor as against the assessee’s payment of interest to Euribor. The assessee did not adduce any documentary evidence namely finalization of comparables inspite of giving sufficient opportunity to the assessee for producing the same. So, the TPO rejected it on the reason that the claim of the assessee is unsubstantiated. Hence, in our opinion, it is appropriate to remit the issue to the file of the Assessing Officer to re-determine the arm’s length after considering the finalization of the comparables which shall be submitted by the assessee so as to determine the same afresh. With these observations, we remit the matter back to the Assessing Officer for fresh consideration. Thus, the ground raised by the assessee is allowed for statistical purposes.

6.1 The facts are that the Assessing Officer made an addition disallowing the accrual of warranties as made by the assessee in the original computation of

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income, where as the assessee claimed the same as expenditure in the revised return "based on subsequent judicial decisions". The Assessing Officer has made the addition in the order based on the disallowance made by the assessee itself in the original computation without any discussion. However during the course of appeal proceedings the assessee was represented by its AR's was given adequate opportunity to furnish the evidences to substantiate their claims with regard to the issue. On 29.08.2013 the AR's appeared and sought time to file written submissions and accordingly the case was adjourned to 05.09.2013. On 05.09.2013 the AR's appeared and filed written submissions on the issue of TP adjustment, but none on the issue of warranty. Subsequently the matter was heard on 14.11.13, 21.11.13 and 21.1.14, no details were regarding the claim of warranty accrual. In the absence of written submissions and details filed in support for the claim on accrual of warranty, the ld. CIT(A) has presumed that the assessee has no evidence to substantiate its claim with regard to the same to be allowed as a deduction. Hence the addition made by the Assessing Officer was upheld and dismissed the ground.

6.2 We have heard both sides, perused the records. In this case, the ld. AR has submitted that 1% of the sum has to be considered as provisions on warranty and it has to be allowed. This is only a provision and not expenditure already incurred and laid out for its purposes of business. Unless the liability for such expenditure is crystallized, the assessee is not entitled to claim the

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deduction in respect of such expenditure. The ld. AR relied on the judgement of the Hon’ble Supreme Court in the case of Rotork Controls India P. Ltd. & Ors. V. CIT [2009] 314 ITR 62, wherein, it was held as under: “Held, reversing the decision of the High Court, that the valve actuators, manufactured by the assessee, were sophisticated goods and statistical data indicated that every year some of these were found defective; that valve actuator being a sophisticated item no customer was prepared to buy a valve actuator without a warranty. Therefore, the warranty became an integral part of the sale price; in other words, the warranty stood attached to the sale price of the product. In this case the warranty provisions had to be recognized because the assessee had a present obligation as a result of past events resulting in an outflow of resources and a reliable estimate could be made of the amount of the obligation. Therefore, the assessee had incurred a liability during the assessment year which was entitled to deduction under section 37 of the Income-tax Act, 1961. The present value of a contingent liability, like the warranty expense, if properly ascertained and discounted on accrual basis can be an item of deduction under section 37. The principle of estimation of the contingent liability is not the normal rule. It would depend on the nature of the business, the nature of sales, the nature of the product manufactured and sold and the scientific method of accounting adopted by the assessee. It would also depend upon the historical trend and upon the number of articles produced. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when: (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation, and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized. The principle is that if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and the facts show that defects existed in some of the items manufactured and sold, then provision made for warranty in respect of such sophisticated goods would be entitled to deduction from the gross receipts under section 37.” 6.3 The assessee, before the authorities below, has not substantiated the claim as to whether it is based on actuarial valuation or it is based on any

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scientific method so as to allow the claim of the assessee or by any past experience. In such circumstances, we are not in a position to allow the claim of the assessee. However, in our opinion, we remit the matter back to the Assessing Officer with the directions to verify the details as may be filed by the assessee regarding basis of determination of warranty provision. If large number of sophisticated goods are manufactured and sold with warranty and based on records shows that the defects existence in some of the items, the provision made by the assessee for warranty claimed on the basis of past experience is allowable under section 37 of the Act. Accordingly, this issue is remitted back to the Assessing Officer.

Sd/- Sd/- (CHANDRA POOJARI) (DUVVURU RL REDDY) ACCOUNTANT MEMBER JUDICIAL MEMBER Chennai, Dated, the 30.06.2016 Vm/- आदेश क� ��त�ल�प अ�े�षत/Copy to: 1. अपीलाथ�/Appellant, 2.��यथ�/ Respondent, 3. आयकर आयु�त (अपील)/CIT(A), 4. आयकर आयु�त/CIT, 5. �वभागीय ��त�न�ध/DR & 6. गाड� फाईल/GF.