Income Tax Appellate Tribunal - Bangalore
Lenovo (India) Private Limited, ... vs Assessee on 8 February, 2012
IN THE INCOME TAX APPELLATE TRIBUNAL,
BANGALORE BENCH 'A'
BEFORE SHRI N BARATHVAJA SANKAR, VICE RESIDENT
AND
SMT. P MADHAVI DEVI, JUDICIAL MEMBER
ITA No.1457/Bang/2010
(Asst. Year - 2006-07)
M/s Lenovo (India) Pvt. Ltd.,
Ferns Icon Level 2,
Doddenakundi Village,
Marathahalli Outer Ring Road,
Marathahalli, Bangalore-560 037. . Appellant
PAN No.AABC13372H
Vs.
The Asst. Commissioner of Income-tax,
Circle-11(5),
Bangalore. . Respondent
Appellant by : Shri Sriram Sesadri, CA
Respondent by : Shri Etwa Munda, CIT-III
Date of Hearing : 08-02-2012
Date of Pronouncement : -02-2012
ORDER
PER P MADHAVI DEVI, JUDICIAL MEMBER :
This appeal is filed by the assessee. The appeal is directed against the order of the Jt. Commissioner of Income-tax (TP) - II at 2 ITA No.1457/B/10 Bangalore dated 8.10.2010. The appeal arises out of the assessment completed u/s 143(3) of the Income-tax Act, 1961
2. The assessee has filed the following concise grounds of appeal :
(1) "The order passed by the Dispute Resolution Panel (DRP) u/s 143(3) read with sec. 144C of the Income-tax Act, 1961 (Act) is contrary to law, facts and circumstances to the present case and in any case, made in violation of principles of equity and natural justice as the assessee was not being given an adequate opportunity of heard and without considering the submissions made by the appellant.
(2) The DRP has erred both in law and on facts in upholding the adjustment based on the order passed u/s 92CA of the Act passed by the learned JCIT (TP-II) (TPO) as the said order was passed without jurisdiction.
(3) The DRP has erred both in law and on facts in arbitrarily upholding the rejection of Resale Price Method (RPM) adopted by the appellant as the Most Appropriate Method (MAM) for import of parts for manufacturing segment and instead adopting the 3 ITA No.1457/B/10 Transaction Net Margin Method (TNMM) by considering the resale of parts initially imported for the manufacturing activity as a separate trading activity in itself.
(4) The DRP has erred both in law and on facts in arbitrarily upholding the adjustment without appreciating that the sale back of the redundant stock of parts ws closely linked to the manufacturing operations carried out by the assessee involving import of parts from the Associated Enterprises rather than a regular business activity.
(5) The DRP has erred both in law and on facts in arbitrarily upholding the TNMM to benchmark the software license and failed to appreciate that the assessee has merely reimbursed the cost of the software procured by the AE from third parties and provided to the assessee.
(6) The DRP has erred both in law and on facts in arbitrarily upholding the data set of comparables for benchmarking manufacturing segment under TNMM on the ground that the data of the comparable set is not in accordance with Rule 10B(4) of the Income-tax Rules, 1962.
4 ITA No.1457/B/10
(7) The DRP has erred in law and on facts in arbitrarily rejecting the claim of risk adjustment and also the standard adjustment of 5 percent from the arithmetic mean margin computed for benchmarking under TNMM for manufacturing segment.
(8) The DRP has erred in disallowing an amount of Rs.272,796,488/- in respect of warranty without appreciating that the said warranty provision has been created in a scientific manner giving due regard to the nature of activity and industry requirements.
(9) The learned DRP has erred in disallowing the R&D cess payable u/s 43B of the Act. (10) The DRP has erred in law and on facts in arbitrarily confirming the disallowance of
Rs.271,418,028/- being marketing support fees paid to IBM as capital expenditure on the ground that if result enduring benefit of capital nature in the hands of the appellant.
(11) The DRP has erred in law and on facts in arbitrarily disallowing Future Billing Adjustment (FBA) and Duty Free Replenishment Certificate (DFRC) receivable written off charged to profit and loss account amounting to Rs.21,91,78,000/- and 5 ITA No.1457/B/10 Rs.5,26,89,000/- respectively on the ground that such expenditure was incurred by IBM India and not by the appellant.
(12) The DRP has erred in law and on facts in upholding the levy of interest u/s 234B and 234D of the Act."
3. At the time of hearing, the learned counsel for the assessee submitted that the assessee is not interested to pursue ground of appeal No.2 and 9. Therefore, these grounds are rejected as not pressed.
4. Coming to the ground Nos. 3 to 7 relating to the transfer pricing adjustment made by the TPO and confirmed by the DRP,
5. The brief facts of the case are that the assessee is engaged in the business of manufacture, import, marketing, distribution and export of information technology systems, software and maintenance services etc. It filed its return of income on 29.11.2006 declaring a loss of Rs.74,89,28,827/-. During the assessment proceedings u/s 143(3) of the Income-tax Act, the Assessing Officer observed that the assessee has entered into various international transactions with its associated 6 ITA No.1457/B/10 enterprises. In view of the same, he made a reference to the TPO u/s 92CA of the Income-tax Act for determination of the arms length price (ALP) with regard to the said international transactions. The TPO, after considering the assessee's contentions with regard to various transactions, accepted the ALP determined by the assessee in its 92CA report as far as 8 transactions are concerned, but made TP adjustment with regard to the following transactions :-
1) Sale of imported parts of raw-material
2) Purchase of imported parts of raw material
3) Software licence and
4) Royalty paid.
6. The TPO rejected the methods followed by the assessee for arriving at the ALP for all the above transactions and adopted the TNMM as the most appropriate method for arriving at the ALP of all the transactions. Thereafter, he determined the ALP as per the TNMM method and the TP adjustment was reported to the assessing authority. The assessing authority after taking into consideration all the TP adjustments made by the TPO, drafted the assessment order and furnished the same to the assessee.
7 ITA No.1457/B/10
7. Aggrieved by the said draft order, the assessee approached the DRP and the DRP after hearing the assessee confirmed the order of the assessing authority and the Assessing Officer has accordingly passed the assessment order making the TP adjustment.
8. Aggrieved, the assessee is in appeal before us.
9. The learned counsel for the assessee Shri Sriram Sesadri submitted that the assessee has followed various methods for computing the ALP of different transactions depending on the nature of transactions and the comparables available such as for the 'sale of parts imported for the purpose of manufacture', the assessee has adopted the resale price method, 'for purchase of imported parts of raw material', it has adopted internal CUP method, for 'software licence' it has adopted CUP method and for the royalty paid, the assessee has adopted external CUP method. The learned counsel for the assessee drew our attention to the order of the TPO to demonstrate that the TPO has not applied his mind to the facts of the case before him for rejecting the methods adopted by the assessee for arriving at the ALP of the various transactions. He has also drawn our attention 8 ITA No.1457/B/10 to various judicial precedents on the issue to demonstrate that where TPO has not been able to find any fault with the method adopted by the assessee for the said purpose, the TPO is bound to accept the TP analysis conducted by the assessee and cannot take a different view. For this purpose he placed reliance upon the Circular No.14 of 2001 issued by the CBDT to the effect that where there was no infirmity in the TP study conducted by the assessee, and the TPO had no basis for disregarding the same for the purpose of computing/framing the assessment and making the TP adjustment, then the TP analysis made by the assessee has to be accepted.
10. The learned counsel for the assessee further submitted that for the subsequent assessment years, i.e for the assessment year 2007-08, the very same TPO had accepted the methods adopted by the assessee for arriving at the ALP for similar transactions and there was no TP adjustment made. He has filed the copies of the TPO's orders u/s 92CA of the Act for the assessment year 2007-08 and also 2008-09 wherein no adjustments were made and the TP analysis made by the assessee has been accepted. The learned counsel for the assessee has also filed before us, the copy of transfer pricing review filed by the 9 ITA No.1457/B/10 assessee for the assessment year 2007-08 to demonstrate that the very same issues had arisen for the subsequent assessment year also.
11. The learned DR on the other hand strongly supported the orders of the authorities below and also filed his written submissions in support of his contentions.
12. 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 TP 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 of the Revenue towards an issue and particularly in the case 10 ITA No.1457/B/10 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 fit 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.
14. As regards ground No.8, the brief facts of the case are that the assessee had acquired the personal computer and laptops division of IBM India and continued business of trading and manufacture of PC's and MCs. The assessee has provided either 1 year or 3 years warranty on sale of PC's and laptops made to its customers in India 11 ITA No.1457/B/10 and the prices for warranty services has been loaded in the sale price of PC's or laptops itself. The assessee debited the actual warranty expenditure incurred during the year and also the additional provision made on the basis of assessment of warranty liability on sales made for the unexpired period to the profit and loss account and claimed it as deduction. The assessing Officer observed that the provision of warranty made is based on Global experience which might not be suitable for India and this being the first year of business for the assessee in India, it has no past experience or data relating to repair of their warranty clients for the sales made. He also observed that assessee has incurred only 22% of the total amount debited to profit and loss account as warranty expenditure and, therefore, the provision created is not based on any real liability, data or statistics but is an unascertained liability. The Assessing Officer, therefore, disallowed the same and added it to the income of the assessee. On appeal, the DRP confirmed the order of the AO and the assessee is in second appeal before us.
15. The learned counsel for the assessee submitted that the assessee has sold PCs and laptops to its customers with a warranty provision 12 ITA No.1457/B/10 and as per the matching principle, the assessee has to make provision for such probable expenditure proportionate to the sales made.
16. The learned counsel for the assessee submitted that the assessee had acquired the business of PCs and laptops from IBM in India and therefore, it has adopted the basis on which IBM was making the provision for warranty in the earlier years. He submitted that the provision is based on scientific method and not on ad-hoc basis. He submitted that the assessee has provided the worksheet which would clearly show that the assessee had scientific method of estimating the liability based on past data and, therefore, the provision of warranty is allowable. In support of its contention, he placed reliance upon the following decisions :
1) Rotork Controls India Pvt. Ltd Vs. CIT, (2009) 314 ITR 62 (SC) 2) CIT Vs. Ericssion and Communication Pvt. Ltd. in 318 ITR 340, (Del) and un-reported decision of the Tribunal in the case of 3) Apple India Pvt. Ltd. in ITA No.609/Bang/2010. 13 ITA No.1457/B/10
He has also filed copies of the said orders before us.
17. He further stated that the assessee had used the past year data of IBM, which was in business till the acquisition of the business by the assessee and that the provision made in the current year has been decreasing where as the actual expenditure on warranty has been increasing in the subsequent years, which would show that the provision made has been expended actually in the later years. He submitted that since the assessee has made the provision on scientific basis, the provision of warranty must be allowed as deduction in the light of the above cited decisions.
18. The learned DR however supported the orders of the authorities below and submitted that although in principle, the Hon'ble Supreme Court in the case of Rotork Controls India Pvt. Ltd., (cited Supra) has held that provision for warranty can be made and claimed against the income for the relevant previous year subject to the fulfillment of the condition mentioned therein, the assessee has not furnished the statistical information with regard to the sale of desk tops and lap tops, as the warranty provision is loaded on the sale price of the 14 ITA No.1457/B/10 products on the basis of the warranty provisions and, therefore, according to him the matter should be remanded back to the AO for reconsideration of the issue afresh.
19. 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 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.
15 ITA No.1457/B/10
20. 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. 16 ITA No.1457/B/10
21. As regards ground No.10, the learned counsel for the assessee submitted that as part of the personal computer business acquired by the assessee from IBM, the assessee had entered into a market support agreement (MSA) with IBM with a view to retain a market share in the stipulated business. He submitted that the assessee wanted to take support from IBM as IBM has well established enterprise sales force and established global sales infrastructure, such as client representation centre etc. for more than 52 years and for this service, the assessee is required to pay IBM a percentage of its revenue. He submitted that for the year under review, the assessee has paid a sum of Rs.27,14,18,028/- as market support agreement fees to IBM and the Assessing Officer has treated the same as the payment for acquisition of goodwill and considered it to be in the nature of capital expenditure and not allowable u/s 37 of the Income-tax Act. He submitted that the DRP has merely concurred with the AO without considering the facts and circumstances of the case. The learned counsel for the assessee emphatically submitted that the payment does not result in any enduring benefit to the assessee but it results only in smooth and efficient carrying on of the business of the assessee. He submitted as per the terms of the agreement, the payment is for marketing and business support services for a fixed period at an agreed consideration 17 ITA No.1457/B/10 and, therefore, it cannot be termed as good will as it is not for using any brand, logo or any trade marks of IBM. In support of assessee's contention that the payments are revenue in nature, the learned counsel for the assessee placed reliance upon the following decisions :
-
1) State Bank of India & Another Vs. Mula Sahakari Sakhar Karkhana Ltd., (2007) AIR 2361 (SC), wherein it has been held that the commercial documents must be construed based on the terms and conditions contained therein.
22. He support his contentions as stated above, the learned counsel for the assessee drew our attention to clause 2.1 of the marketing support services agreement placed at page No. 53 of the paper book to demonstrate the nature of the services rendered by the IBM for which the payment is made. He submitted that the assessee being a prudent businessman has engaged IBM to carry on such marketing and allied services for the purpose of maintaining and increasing operating revenue of the business and, therefore, has to be treated as revenue expenditure. For the contention that any expenditure incurred for carrying on business efficiently is revenue in nature, the learned 18 ITA No.1457/B/10 counsel for the assessee has placed reliance upon the following other decisions -
1) S.A Builders Ltd. Vs. CIT (2007) - 288 ITR 1 (SC); and
2) CIT VS. Mico Ltd., (2007) - 163 TM 510 (Kar), wherein it has been held that the commercial expediency of an expenditure is to be decided by a businessman and decision to incur or not to incur such expenditure cannot be tested on the touchstone of strict legal liability to incur such an expenditure.
23. He also placed reliance upon the decision of Hon'ble Supreme Court in the case of Empire Jute Manufacturing Co. Ltd. Vs. CIT reported in 124 ITR 1, for the proposition that even if the assessee gets any enduring benefit from the said expenditure yet if it is for the smooth efficiency in carrying on day to day business operations of the company, then it is in the filed of revenue and not in the filed of capital. Thus according to him the expenditure must be allowed as deduction u/s 37 of the Income-tax Act.
24. The learned DR however placed reliance upon the order of the AO and the DRP.
19 ITA No.1457/B/10
25. 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 3rd 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 20 ITA No.1457/B/10 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.
26. In the result, this ground of appeal is allowed.
27. As regards ground No.11, the brief facts of the case are that the assessee, after acquiring the business of PCs and laptops division from IBM during the previous year, continued to carry on manufacturing and trading operations of PCs and laptops using the same facility and sales have been made through the same dealership net work used by the IBM in its business prior to the acquisition. The future billing adjustment reserve of Rs.12,501,000/- was a liability towards various claims/special discounts payable to distributors/dealers of IBM 21 ITA No.1457/B/10 India, whereas the actual pay outs relating to the period upto the effective date of take over i.e 11th May, 2005 was 23,16,79,000/- and accordingly, the difference amounting to Rs.21,91,78,000/- has been charged to the profit and loss account and this aspect was specifically mentioned in the notes to the financials of the assessee. The learned counsel for the assessee submitted that the above expenditure has been incurred over and above the estimated liability which was taken over from IBM and, therefore, relates to the carrying on of the assessee's business and such expenditure has been claimed as revenue expenditure. The learned counsel for the assessee further submitted that as regards duty free replenishment certificates receivable are concerned, they were also taken over from IBM India and were available for utilization against import of inputs used in the manufacture of goods without payment of customs duty. The learned counsel for the assessee submitted that the Govt. of India vide notification No. 24/2005 - customs dated March 1, 2005 has exempted custom duty on all imports of computer parts and, therefore, the DFRC receivable was no longer utilizable and was hence written off and charged to the profit and loss account as revenue expenditure, since the assessee was also in the same line of business. The learned counsel for the assessee submitted that these two expenses have been 22 ITA No.1457/B/10 disallowed by the AO on the ground and these expenditure are incurred by IBM and not by the assessee for the purpose of its business and that these liabilities must have been included in the purchase prices paid to IBM. He submitted that the AO held that to claim any expenditure as written off , it must be taxed as income in the hands of the assessee in the previous years and as the assessee has not offered the above expenditure as income for the earlier years, the same cannot be allowed in this year. The learned counsel for the assessee further submitted that since the dealers have not submitted the claim in full to IBM before the acquisition of business by the assessee, the IBM has failed to record or recognize such liability in its books of accounts and the assessee has incurred the expenditure after its taking over of business only to protect its business interest and for smooth functioning of the routine business operations of the assessee. He submitted that the future billing adjustment is done due to commercial expediency, as the assessee requires the services of the business partners/distributors and dealers to continue and carry on the business on regular basis and, therefore, it must be allowed as a deduction. In support of its contentions, he placed reliance upon the decision of the Hon'ble Supreme Court in the case of CIT Vs. Veerabhadra Rao, K Koteswara Rao and Co. (1985) - 155 ITR 152 23 ITA No.1457/B/10 (SC), wherein it has been held that in case of Succession of the business, the successor steps into the shoes of predecessor, and, therefore, the treatment must be similar, as if such claim has been made on the predecessor himself. He also placed reliance upon the decision of the Hon'ble Madras High Court in the case of CIT Vs. Georgepolous (1984) 146 ITR 380 (Mad), wherein under similar circumstances, it was held that such payouts for protecting the business interests must be allowed as revenue expenditure, even though the assessee was not obligated to make such payment. In view of the same, he prayed that the above payments should be allowed as revenue expenditure.
28. The learned DR however supported the orders of the authorities below and submitted that these expenditure are relating to the period before acquisition of the business by the assessee and, therefore, it cannot be claimed by the assessee for the relevant assessment years.
29. Having heard both the parties and having considered the rival contentions and judicial precedents on the issue, we find that when the assessee has taken over the division of desk tops and lap tops from IBM, the assessee has also taken over the liabilities, which include the 24 ITA No.1457/B/10 commission and discounts to the dealers. As held by the Hon'ble Supreme Court in the case Veerabhadra Rao (cited Supra), the successor of a business steps into the shoes of its predecessor and is liable to meet any claims against the predecessor. Similarly as held by the Hon'ble Madras High Court in the case of Georgeopolous (cited Supra) any expenditure incurred by the assessee to protect its business and to carry on its business in a smooth manner is to be allowed as revenue expenditure. In the case before us, no doubt the future adjustment billing is relating to the sales made by the IBM during the earlier financial years, but the assessee is bound to carry on business with the said dealers in future and for that purpose it has to maintain cordial and good relationship with the said dealers. For such purpose, the assessee is bound to make payments to maintain the business relations with the dealers and such payments have to be considered as business expenditure of the assessee.
30. Coming to the duty free replacement certificates (DFRC), we agree with the contentions of the learned counsel for the assessee that on the notification of the Central Govt. when all the imports of the computer parts are custom free, these certificates become useless and cannot be utilized by the assessee. However they have already 25 ITA No.1457/B/10 entered the books of the assessee as current assets and, therefore, the assessee had to write them off and claim the same as revenue expenditure.
31. In view of the same, we are inclined to allow this ground of appeal of the assessee.
32. As regards ground No.12 is concerned, we find that it is consequential in nature and therefore, the AO is directed to give consequential relief to the assessee if any.
33. In the result, the appeal filed by the assessee is partly allowed.
Order pronounced in the open court on 16th Mar, 2012.
Sd/- Sd/-
(N BARATHVAJA SANKAR) (P MADHAVI DEVI)
VICE PRESIDENT JUDICIAL MEMBER
Vms.
Bangalore
Dated : 16/03/2012
26 ITA No.1457/B/10
Copy to :
1. The Assessee
2. The Revenue
3.The CIT concerned.
4.The CIT(A) concerned.
5.DR
6.GF By order
Asst. Registrar, ITAT, Bangalore.