TMI Blog2008 (9) TMI 420X X X X Extracts X X X X X X X X Extracts X X X X ..... puting the book profit under section 115JB. 3. In its profit and loss account, warranty charges amounting to Rs. 4,04,12,572 were debited by the taxpayer company. The said amount was inclusive of the warranty expenses actually incurred by the taxpayer company to the extent of Rs. 1,78,73,650 and the remaining amount of Rs. 2,25,38,920 was on account of provision made for anticipated warranty expenses in respect of the remaining part of the warranty period. According to the Assessing Officer, the amount that may be payable by the taxpayer company on account of possible claims of warranty arising in the future constituted its contingent liability and the provision made for such contingent liability was not deductible while computing its total income. He, therefore, disallowed the same while computing the total income of the taxpayer under the normal provisions of the Act and also added the same while computing its book profit under section 115JB. The matter was carried before the ld. CIT(A) and it was submitted on behalf of the taxpayer company before him that the provision for anticipated liability on account of warranty claim for unexpired period was made on scientific basis taki ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed order of the learned CIT(A) that the provision for warranty made by the taxpayer company at the rate of 2 per cent of the total turnover was highly excessive taking into consideration its own past history wherein such provision was required to be made at only 0.72 per cent. However, as clarified by the learned counsel for the taxpayer, the provision of 2 per cent as referred to by the learned CIT(A) in his impugned order was in the context of a case of Voltas Ltd. decided by Mumbai Bench of ITAT whereas the provision made for warranty by the taxpayer in the present case was only to the extent of 0.75 per cent. We, therefore, hold that the decision of Hon'ble Punjab and Haryana High Court in the case of Majestic Auto Ltd. on a similar issue is squarely applicable in the present case and respectfully following the same, we uphold the impugned order of the learned CIT(A) allowing the deduction claimed by the taxpayer on account for provision for warranty holding the same to be an ascertained liability. Similarly, we also uphold his impugned order deleting the addition made by the Assessing Officer of the said amount while computing the book profit of the taxpayer company under sect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e decision of Hon'ble Bombay High Court in the case of CIT v. Bangalore Clothing Co. [2003] 127 Taxman 637. In the said decision, it was held by the Hon'ble Bombay High Court in this context that if any receipt forms part of the operational income of the taxpayer having regard to its dominant business, the same would be entitled to be included in the profits of the business for the purpose of computing deduction under section 80HHC. According to the ld. CIT(A), all the receipts i.e., sale of scrap, amounts written back and sale proceeds of spare parts included in the miscellaneous income of the taxpayer company were directly related to its dominant business. He, therefore, held that the same forming part of its operational income was liable to be included in the "profits of the business" for the purpose of computing deduction under section 80HHC. 8. After considering the rival submissions and perusing the relevant material on record, we find no infirmity in the impugned order of the learned CIT(A) holding that the miscellaneous income of the taxpayer was eligible for inclusion in the profits of the business for the purpose of computing deduction under section 80HHC. As rightly he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gain has a very close nexus with the export activity of the company. Relying inter alia on the decision of Delhi Bench of ITAT in the case of Smt. Sujata Grover v. Dy. CIT [2002] 74 TTJ 347, it was contended that the same thus was rightly claimed as part of the eligible profits. After considering the submissions made on behalf of the taxpayer, it was held by the ld. CIT(A) that forex gain relating to the export proceeds was the direct result of the export sales and taking into consideration this close nexus between the two, it was not possible to exclude such gain from the export turnover. He, therefore, directed the Assessing Officer to include the said gain even in the figure of export turnover (numerator) for the purpose of computing exemption under section 10A/10B. 11. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue has also been raised by the taxpayer in ground No. 4 of its appeal being ITA No. 1189/Delhi/2005. At the time of hearing before us, the learned counsel for the taxpayer, however, has not pressed the same thereby conceding this issue in favour of the revenue. Accordingly, the impugned o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a Video Ltd. v. Jt. CIT [2002] 122 Taxman 28 (Delhi) (Mag.), it was contended on behalf of the taxpayer that as a result of acquisition of the said software, only an operational or commercial advantage was obtained which being in the revenue field, the expenditure incurred on such acquisition was a revenue expenditure. 16. The details of software expenses claimed by the taxpayer were examined by the ld. CIT(A) and on such examination, he found that the same were incurred for acquiring the following softwares:- "(i) Software for TDS calculation, which needs to be revised each year based on changes in Budget Notifications; (ii) E-CRM networking/Internet gateway for B2B, which requires to be updated periodically based on changes in Marketing requirement, change in product line, new launches etc.; (iii) License fees etc., payable for usage of certain application software and which have no reuse or sale value; (iv) Design and Development/Consultancy charges for Software development which do not have reuse/sale value. (v) Payment of SAP Service module is related to the implementation of SAP by the appellant company during the assessment year 2000-01, the expenses related to w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nch of the Tribunal in the said case, where the advantage consists merely in facilitating taxpayer's trading operations or enabling conduct of taxpayer's business more efficiently or more profitably, the expenditure would be on revenue account. He submitted that the details of the software expenditure incurred by the taxpayer in the present case as given in Annexure-4 would make it clear that the said expenditure was incurred for improving the day-to-day efficiency and for carrying out the business of the taxpayer company in a more efficient manner. He contended that the said expenditure thus was incurred on revenue account as held by the Special Bench of the Tribunal in the case of Amway India Enterprises and the softwares acquired by the taxpayer company being mere facilitators, the expenditure incurred thereon was rightly held by the learned CIT(A) as of revenue in nature. 20. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that a similar issue has been considered and decided by Delhi Special Bench of ITAT in the case of Amway India Enterprises. The conclusions drawn by the Special Bench of the Tribunal in the said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es below when this issue came to be decided by them and it would be in the interest of justice to give them an opportunity to re-examine the same in the light of criteria/guidelines laid down by the Special Bench. Accordingly, we set aside the impugned order of the learned CIT(A) on this issue and restore the matter to the file of the Assessing Officer for deciding the same afresh as per the guidelines laid down by the Special Bench of ITAT in the case of Amway India Enterprises. Ground No. 5 of the revenue's appeal is accordingly treated as allowed for statistical purposes. 22. The next issue raised in ground No. 6 of the revenue's appeal relates to the taxpayer's claim on account of loss due to fluctuation in foreign exchange rate. 23. While finalizing its books of account, the foreign currency transactions were reinstated by the taxpayer company at the exchange rate prevailing on the balance sheet date and the resulting loss on account of foreign exchange fluctuation on such reinstatement of current assets or liabilities amounting to Rs. 31,33,745 was debited to the profit and loss account. Similarly, the gain due to fluctuation in foreign exchange amounting to Rs. 14,00,761 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to the benefit flown to the parent company. The learned CIT(A), however, deleted the disallowance made by the Assessing Officer on this issue holding that as the expenditure on advertisement and sales promotion was incurred by the taxpayer company wholly within India, no benefit had accrued to its parent company in Japan. In addition to the disallowance of 10 per cent made out of advertisement and sales promotion expense on the ground that the same was attributable to the brand promotion resulting in benefit to the parent company in Japan, a further disallowance of 10 per cent was made by the Assessing Officer out of advertisement and sales promotion expenses treating the same to be of capital nature on the ground that advantage of enduring nature had accrued to the taxpayer company. The learned CIT(A), however, deleted the said disallowance observing that as the memory of the customers is short and advertisement is required to be done on year to year basis, the expenditure incurred on advertisement and sales promotion could not be said to have resulted in accrual of any benefit of enduring nature to the taxpayer company. He, therefore, held that the said expenditure was of reven ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the case of Nestle India Ltd. v. Dy. CIT [2007] 111 TTJ 498 stating that a similar issue involved in the said case has been decided by the Tribunal in taxpayer's favour. He also placed reliance on the decision of Mumbai Bench of ITAT in the case of Star India (P.) Ltd. v. Addl. CIT [2006] 103 ITD 73 (TM). As regards the disallowance of 10 per cent made by the Assessing Officer out of advertisement and sales promotion expenses treating the same as of capital nature, the learned counsel for the taxpayer submitted that since the expenditure on advertisement and sales promotion is required to be incurred every year, there was no benefit of enduring nature derived by the taxpayer company by incurring the said expenditure. He also submitted that the said expenditure in any case was made by the taxpayer company on revenue account and the same, therefore, could not be treated as capital expenditure even if the test of enduring benefit is assumed to be satisfied. In support of this contention, he relied on the decision of Hon'ble Supreme Court in the case of Empire Jute Co. wherein it was held that the enduring benefit test is not a conclusive test for determining the allowability of a pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e incurred wholly and exclusively for the purpose of its business and it could not be disallowed on the ground that it might have also benefited the taxpayer's principal. To the similar effect is the decision of Delhi Bench of ITAT in the case of Nestle India Ltd. cited by the learned counsel for the taxpayer wherein it was held that advertisement and sales promotion expenses incurred by the taxpayer for promoting sales in India in respect of products manufactured by it under various brands of a foreign company were allowable in entirety even though it might have benefited the non-resident company who owned the said brands. Keeping in view both these decisions of the Tribunal and taking into consideration the facts of the case as discussed above, we hold that the disallowance of 10 per cent made by the Assessing Officer out of advertisement and sales promotion expenses on the ground that the same resulted in the benefit to the parent company was not sustainable and the learned CIT(A) was fully justified in deleting the same. 30. As regards the further disallowance of 10 per cent made by the Assessing Officer out of advertisement and sales promotion expenses treating the same to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -amended provisions of section 43A as applicable to the year under consideration. 33. At the time of hearing before us, the learned representatives of both the sides have agreed that this issue is squarely covered in favour of the taxpayer by the judgment of Hon'ble Delhi High Court in the case of Woodward Governor India (P.) Ltd. wherein it was held that in a case where a taxpayer has acquired any capital asset from abroad for the purpose of his business or profession on credit or on deferred payment terms or against a loan in foreign currency and the whole or part of the cost of such asset or of the loan in foreign currency is outstanding as on the date on which there was a change in the rate of exchange of currency, the original actual cost to the taxpayer of such asset is required to be increased or as the case may be reduced correspondingly, inter alia, for the purposes of depreciation. It was also held that the amendment made to section 43A with effect from 1-4-2003 was prospective and would accordingly apply in relation to assessment year 2003-04 and subsequent years. As the assessment year involved in this appeal is 2001-02, we respectfully follow the judgment of Hon'ble ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er section 143(1). The learned CIT(A), however, noted that the provisions of section 234D have been introduced in the statute by the Finance Act, 2003 with effect from 1-6-2003. According to him, the said provisions thus were applicable only in relation to assessment year 2003-04 onwards and interest under that provision could not be levied in the taxpayer's case involving assessment year 2001-02. 39. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue is squarely covered in favour of the taxpayer by the recent decision of Delhi Special Bench of ITAT in the case of ITO v. Ekta Promoters (P.) Ltd. [2008] 113 ITD 719 wherein it has been held that interest under section 234D is chargeable from assessment year 2004-05 and the same could not be charged for earlier years. Since the assessment year involved in the present appeal is 200102, we uphold the impugned order of the learned CIT(A) cancelling the interest levied by the Assessing Officer under section 234D respectfully following the decision of the Special Bench in the case of Ekta Promoters (P.) Ltd. Ground No. 10 of the revenue's appeal is accordingly di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the taxpayer were consumer electronic goods, it was pertinent for the appellant to provide appropriate 'after sales services and support' beyond the warranty period to ensure that consumers of goods receive good value for their money and quality service. He contended that servicing of these components thus constituted an essential ingredient of the business activity of the taxpayer company and was inextricably linked to the goods being sold by it. 45. As regards the advisory service income received from Sony Corporation of Hong Kong Ltd. in pursuance of an advisory service agreement, he submitted that for carrying out its manufacture and sales operations in the Indian market, the taxpayer company needs to constantly update its knowledge of various technological advancements, customer perceptions and changes in the demand pattern in the Indian market. As a result, it gains substantial knowledge of the sales and marketing practices prevalent in the Indian market and with the aid of this experience and knowledge gained, it renders advisory services to Sony Corporation of Hong Kong Ltd. relating to Sony products. He contended that the advisory services rendered by the taxpayer c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 80-IA was explained by the Hon'ble Apex Court. 48. We have considered the rival submissions and also perused the relevant material on record. It is observed that a similar issue relating to eligibility of service income and miscellaneous income earned by the taxpayer for deduction under section 80-IA had arisen for consideration before the Tribunal in taxpayer's own case for assessment year 2000-01 and vide its order dated 31-8-2004, the Tribunal decided the same against the taxpayer for the following reasons given in paragraph No. 23 of the said order:- "23.The next question for our consideration is as to whether the receipts from activity of services and the miscellaneous incomes can be considered to be profits derived from industrial undertaking of the taxpayer. We find that the legal position in this regard is now well-settled by various judgments of the Apex Court. The decision of the Apex Court in the case of Cambay Electrical Supply Industrial Co. Ltd 113. ITR 84 makes a distinction between the expression namely "attributable to" and "derived from". According to the Hon'ble Apex Court, the expression "attributable to" has a much wider import than the expression "deriv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the taxpayer. Therefore, on this count, we sustain the stand of the taxpayer only to the extent mentioned herein above. Before we part, we may discuss the alternative plea of the appellant that in order to exclude the aforesaid incomes from profits eligible for deduction under section 80-IA, what was required to be excluded was the net income of such activity and not the gross receipts from such activities. We do not find any infirmity in the aforesaid pleas of the taxpayer. For this limited purpose, we remit the issue to the file of the Assessing Officer to re-work the deduction allowable to the taxpayer under section 80-IA on the basis of the aforesaid discussion. The second ground is accordingly disposed of." 49. Before us, the learned counsel for the taxpayer has submitted that the decision of the Tribunal on this issue rendered in assessment year 2000-01 was not contested by the taxpayer company as the same did not have any adverse financial impact on its total tax liability since it was liable to pay MAT for that year under section 115JB. He has contended that the said decision, therefore, may not be taken as a binding precedent on merits and the issue may be considered an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch income should be the industrial undertaking itself. In the present case, the business of the eligible industrial undertaking of the taxpayer company is to manufacture and sale of electronic goods and keeping in view the nature of this main business, we are of the view that the miscellaneous income and service income earned by the taxpayer could not be said to have been derived from such business by the said industrial undertaking for the purpose of allowing deduction under section 80-IA. As regards the reliance of the learned counsel for the taxpayer on the decision of Hon'ble Bombay High Court in the case of Bangalore Clothing Co., it is observed that the same was rendered in the context of computation of profits of the business for the purpose of computing deduction under section 80HHC and as held by their Lordships having regard to the definition given in Explanation (baa) below section 80HHC, the operational income was eligible to be included in the profits of the business for the purpose of computing deduction under section 80HHC. The scope of operational income has also been explained by the Hon'ble Bombay High Court by pointing out that if any income is generated from th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he action of the Assessing Officer in excluding the service income from the profits for the purpose of computing deduction under section 80HHC. 52. The learned counsel for the taxpayer, at the outset, submitted that service income constituted a part of business income of the taxpayer company which is evident from the fact that in its return of income, the said income was offered to tax under the head "Profits and gains of business or profession". He submitted that this treatment given by the taxpayer company was accepted by the Assessing Officer himself while completing the assessment and he, therefore, was not justified in excluding the said income from profits of the business for the purpose of computing deduction under section 80HHC. Referring to Explanation (baa) to section 80HHC, he submitted that the said Explanation provides for certain specific deductions such as rent, interest, brokerage, commission or other receipts of similar nature for the purpose of computing the profits of the business. He contended that as the service income is essentially linked with the prime business activity of the taxpayer company, the same cannot be clubbed with residuary sources of income as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Clothing Co. 54. The learned DR, on the other hand, submitted that the service income in question was earned by the taxpayer company for the services rendered to its sister concern abroad and keeping in view the nature of such services rendered by it relating to marketing, it cannot be said that it has got any link either direct or even indirect with the main business operations of the taxpayer company. She contended that the said income, therefore, cannot constitute the operational income of the taxpayer as explained by the Hon'ble Bombay High Court in the case of Bangalore Clothing Co. and the same was liable to be excluded from the profits of the business for the purpose of computing deduction under section 80HHC as rightly held by the Assessing Officer as well as by the learned CIT(A). 55. We have considered the rival submissions and also perused the relevant material on record. It is no doubt true that the service income earned by the taxpayer company was shown by it as business income and this treatment was even accepted by the Assessing Officer. However, this alone was not sufficient to establish that the said income was eligible for inclusion in the profits of busines ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the taxpayer firm was in the business of export of polished diamonds out of India. During the relevant year, it undertook work of polishing diamonds on job work/contract basis for third parties in India and the income earned from the said activity in the form of service charges was claimed to be includible in the profits of the business for the purpose of computing deduction under section 80HHC. This claim of the taxpayer, however, was held to be not allowable by the Hon'ble Bombay High Court observing that the activity of polishing undertaken by the taxpayer firm on job work/contract basis having no nexus with its main export activities, the service charges could not be considered as part of the business profits while working out deduction under section 80HHC. Keeping in view the said decision of Hon'ble Bombay High Court in the case of K.K. Doshi Co. and the broad guidelines laid down in the case of Bangalore Clothing Co. as applied to the facts of the case, we are of the view that there was no infirmity in the impugned order of the learned CIT(A) excluding the service income earned by the taxpayer company from the profits of the business for the purpose of computing deductio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nts written back etc., it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 3 of the revenue's appeal. 60. As regards ground No. 4 of the revenue's appeal relating to exclusion of excise duty from turnover for deduction under section 80HHC, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 4 of the revenue's appeal. 61. The issue raised by the revenue in ground No. 5 relating to the taxpayer's claim on account of loss due to fluctuation in foreign exchange rate has already been decided by us in the foregoing portion of this order while disposing of ground No. 6 of the revenue's appeal for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ITA No. 819/Delhi/2007-Taxpayers appeal for A.Y. 2002-03 66. Ground No. 1 raised by the taxpayer in this appeal is general seeking no specific adjudication from us. 67. Ground No. 2 relates to the disallowance of taxpayer's claim for deduction under section 10A/10B in respect of miscellaneous Income. 68. The taxpayer company is running two software development centres at Bangalore viz., S.I.S.C. and S.A.R.D. for development of product related and application software. SISC and SARD were eligible for deduction under sections 10A and 10B respectively during the year under consideration. While computing the said deductions, the taxpayer company had included miscellaneous income comprising of notice pay received from employees amounting to Rs. 54,017 and compensation of Rs. 83,06,011 received from Sony International (Europe) GmbH on cancellation of contract for research and development in relation to application software. The Assessing Officer, however, excluded the said miscellaneous income aggregating to Rs. 83,60,028 from the profits eligible for the said deductions stating that the same has not been derived from the business of the undertaking. The action of the Assessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rime business activity of the taxpayer company and the same, therefore, was the income derived from the said activity which is eligible for the said deduction. He submitted that the theory of income derived adopted by the Assessing Officer as well as by the learned CIT(A) relying on the various judicial pronouncements rendered in the context of various provisions of Chapter VI-A cannot be applied in the present case as the issue involved is relating to the exemption provisions of section 10A/10B falling under Chapter III which is separate and distinct from Chapter VI-A. 70. The learned DR, on the other hand, submitted that only the income derived from the export of software is eligible for deduction under sections 10A and 10B and unless there is a direct nexus between the miscellaneous income and the main business of the undertaking, such income cannot be said to be derived from the said business in order to be eligible for deduction under sections 10A and 10B. She contended that the income in question received by the taxpayer on account of notice pay from employees and compensation for cancellation of contract had no such direct nexus with the business of export of software and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ived by the taxpayer company from its employees is not certainly reimbursement of the salary expenses incurred by the taxpayer company and the same, therefore, cannot be adjusted against such expenditure as sought to be contended by the learned counsel for the taxpayer. We, therefore, hold that the notice pay received by the taxpayer company from its employees was not eligible for deduction under section 10A as rightly held by the Assessing Officer and the learned CIT(A) was fully justified in upholding the action of the Assessing Officer on this issue. The impugned order of the learned CIT(A) on this issue is accordingly upheld. 72. As regards the other amount of Rs. 83,06,011 forming part of miscellaneous income, it is observed that the said amount was received by the taxpayer company from Sony International (Euro), Germany on account of cancellation of a contract. The said contract was awarded by Sony International (Euro) to the taxpayer company in relation to research and development of application software in its centre located at Bangalore. As already noted, the said centre at Bangalore was set up for development of product related and application soft wares and the contrac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e and service income which stands disallowed by the Assessing Officer as well as by the learned CIT(A), it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1189/Delhi/2005. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) and direct the Assessing Officer to allow the claim of the taxpayer on this issue and allow ground No.3 of the taxpayer's appeal. 74. As regards the issue raised by the taxpayer in ground No. 4 relating to its claim for deduction under section 80HHC in respect of service income, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 3 of the revenue's appeal for assessment year 2001-02 being ITA No. 1189/Delhi/2005. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) on this issue and direct the Assessing Officer to allow the claim of the taxpayer and allow ground No. 4 of the taxpayer's appeal. 75. The next issue raised in ground No. 5 relates ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was disallowed by the Assessing Officer. Thus, a definite stand was taken by the Assessing Officer relying on the auditors' comment that the said expenditure was actually pertaining to assessment year 2002-03 and this being so, we are of the view that the deduction claimed by the taxpayer for the said expenditure in assessment year 2002-03 should have been allowed by the Assessing Officer. As rightly contended by the learned counsel for the taxpayer before us, there was no justification in disallowing the said deduction in both the years i.e., assessment years 2002-03 and 2003-04 as done by the Assessing Officer. We, therefore, direct the Assessing Officer to allow the claim of the taxpayer for deduction on account of the expenditure of Rs. 6,81,551 in question incurred by the taxpayer on account of retrospective price revision made by its supplier in assessment year 2002-03. Ground No. 5 is accordingly allowed. 79. The next issue raised in ground No. 6 of the taxpayer's appeal for assessment year 2002-03 relates to the disallowance made on account of expenditure incurred by the taxpayer company on training of its employees. 80. During the year under consideration, a sum of Rs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s employees had definitely given a benefit of enduring nature to it and since the disallowance made by the Assessing Officer out of the said expenditure to the extent of 50 per cent assuming that such benefit had accrued for a period of two years only was quite fair and reasonable, the learned CIT(A) was fully justified in confirming the same. 83. We have considered the rival submissions and also perused the relevant material on record. It is by now well-settled that if the expenditure incurred by the taxpayer is of revenue nature, the same is entirely deductible even if there accrues an advantage of enduring nature in favour of the taxpayer as a result of the said expenditure. This is because going by the very nature of the expenditure being revenue, it operates in the revenue field leaving the capital field untouched. The enduring benefit resulting from the said expenditure may justify the action of the taxpayer to write off the said expenditure in his books of account over a period of more than one year. However, such accounting treatment by itself is not conclusive to decide the nature of the relevant expenditure, whether capital or revenue. In the case of Amar Raja Batteries ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned CIT(A) confirming the disallowance made by the Assessing Officer to the extent of 50 per cent on this issue is, therefore, reversed and the Assessing Officer is directed to allow the said expenditure in full. Transfer Pricing Issue involved in assessment year 2002-03 84. Ground Nos. 7 to 11 raised in the taxpayer's appeal and ground No. 9 raised in the revenue's appeal involve issues relating to transfer pricing and pertain to the addition made by way of "adjustments" under section 92CA of the Act by determining higher arm's length price than disclosed by the taxpayer in the international transactions carried with its associated enterprises "AEs". 85. The taxpayer Sony India (P.) Ltd. (Sony India) is a wholly owned subsidiary of Sony Corporation, Japan (Sony Japan). Sony Japan is a global leader in consumer electronics business. Its product profile includes audio and video products, televisions, projectors, play stations, media tapes, motion pictures, insurance, leasing and credit card, satellite distribution and other allied businesses. However, consumer electronics business alone contributes about 68 per cent of total revenue of Sony Corporation. 85.1 Sony India is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y services provided to AEs 4.04 ------------------------------------------------------------ 6. Reimbursement of advertisement expenses 14.88 ------------------------------------------------------------ 7. Import of moulds 0.62 ------------------------------------------------------------ 8. Reimbursement for defective CRTs and rebate 0.71 received ------------------------------------------------------------ 9. Services received for IT, communication and 1.14 sharing of best practices ------------------------------------------------------------ 86.1 The taxpayer had imported electronic components and CRTs from its associated concerns and had claimed that above items were acquired at Arm's Length Price and for that purpose had relied upon Transactional Net Margin Method (TNMM). It had chosen the foreign AEs from whom the components were imported as tested parties and had computed the profit of AEs with comparable chosen from Indian and other data bases. The same method was chosen for the distribution activities relating to high-end electronic products, projector tapes etc. where the taxpayer was taken a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acturing and trading activities separately, the TPO in his report further observed as under:- "Two sets of transactions can be closely interlined only when they impact each other's profitability in a material manner. No such conclusion can be arrived at in these sets of facts. The TP report's approach is contrary to the claim forwarded during the proceedings. It is an implicit rejection of separate analysis of the trading activity under TNMM. The onus to explain this departure and to sort out the void created by this rejection rests on the taxpayer which has not been discharged." In the long arguments as also in oral submissions, Shri Bhutani, the ld. representative of the taxpayer, did not challenge above action of the TPO. Further, no reference was made before the Tribunal to any consolidated figures. Accordingly, we do not deem it necessary to carry further discussion on this point. Most Appropriate Method 87.2 The TPO agreed that TNMM was the Most Appropriate Method in the circumstances as it is more tolerant to functional differences and accounting differences at gross level gets eliminated due to a comparison at net level while selection of comparables. The TPO furt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... parity for economies of scale ------------------------------------------------------------ Filter 5 To exclude those companies To identify those whose manufacturing sales, as companies which a percentage of total sales is are substantively less than 90% into manufacturing activity which is the focus of our analysis ------------------------------------------------------------ Filter 6 To exclude companies having To identify controlled party transactions companies with uncontrolled transaction ------------------------------------------------------------ As a result of the above search process, four companies were identified (i) BPL Limited (ii) Videocon Appliances Limited (iii) Videocon Communication Limited (iv) Videocon International Limited." 88. The taxpayer objected to the selection of above enterprises for comparison. The BPL Limited was stated to have carried on transactions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ration. The TPO accepted above argument and thought it reasonable to allow deduction of 20 per cent out of mean margin of profit of comparables. Therefore, instead of 9.01 per cent calculated as above, he took 80 per cent thereof i.e., 7.2 per cent as operating average profit for purposes of comparison and for determination of Arm's Length Price. In order to determine the operating profit of the taxpayer, the TPO made some adjustments of expenses claimed in the accounts by the taxpayer. He found that in its TP report, the taxpayer had not compared profit margin on its manufacturing activities as it had chosen overseas AEs as tested parties. The taxpayer was asked to furnish segmental accounts of manufacturing and trading activities. This was done. 90.1 On examination of taxpayer's accounts, the TPO found that taxpayer had received Rs. 14.88 crores as assistance from its AEs Sony Marketing Asia Pacific, Singapore and Sony, UAE to meet its advertisement and selling expenses. He found that out of total advertisement and selling expenses of Rs. 40.85 crores, only Rs. 25.97 crores were shown in profit and loss account by netting off the reimbursement of Rs. 14.88 crores. The TPO did n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12.1-1 Proviso to section 92C(2) permits a maximum variance of 5 per cent from the Arm's Length Price. In this case the difference of 12.44 per cent being more than 5 per cent is not acceptable. Hence it is concluded that the price adopted by the taxpayer have to be reduced by Rs. 65,034,038 which is 11.07 per cent of the value of the international transactions. Therefore, 88.93 per cent of the international transaction value becomes the arm's length price. The ALP for different groups of transactions is summarized in the table below:- ----------------------------------------------------------- Transaction Description Amount paid as Arm's Length Price per books (88.93 per cent of Amount paid) ----------------------------------------------------------- Purchases from Sony Rs. 559,219,217 497,313,650 Marketing Asia Pacific, Singapore ----------------------------------------------------------- Purchases from Sony Rs. 5,166,951 4,594,970 Computer Entertainment Europe Ltd. ----------------------------------------------------------- Purchases from Sony Rs. 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -------------------------------------------------- Sony Electronics (Singapore) 604,101,283 480,804,211 Pte. Ltd. - Sony Display Device Division ("SDD") ------------------------------------------------------------ Sony Electronics (Malaysia) 826,893 658,124 SDN BHD ("SEM") ------------------------------------------------------------ Sony Corporation, Tokyo 190,604,872 151,702,418 ("SC") - Sony Trading International Corporation ("STIC") ------------------------------------------------------------ Sony Technology Malaysia 353,511,552 281,359,844 SDN BHD ("STM") ------------------------------------------------------------ Shanghai Suoguang Visual 38,519,161 30,657,400 Products Co. Ltd. ("SSV") ------------------------------------------------------------ Total 1,699,736,071 1,352,655,163 ------------------------------------------------------------ 12.2-2 The Assessing Officer shall, therefore, make an addition of Rs. 347,080,908 to the total income of the Taxpayer." 91. The TPO also found that the taxpayer had exported 8680 units of 21 inches Television for Rs. 9,964.65 each to Sony Japan. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Officer, the learned CIT (Appeals) did not find any force in objections on violation of principle of natural justice, on not providing sufficient opportunity of being heard, on order of TPO being not binding on the Assessing Officer, on validity of reference to the TPO and on choice of the tested party. All these objections raised on above issues were rejected by the learned CIT (Appeals) after a detailed discussion. Above issues have not been carried in further appeal. No reference was made to above objections in oral or in the written submissions by the ld. Authorized Representative of the taxpayer. Therefore, we do not deem it necessary to refer to the finding recorded by the learned CIT (Appeals) on above issues. 93.1 The learned CIT (Appeals) held that for purposes of transfer pricing evaluation, each and every transaction should be taken as a distinct and separate transaction. Profit of each segment should be separately worked out through an accepted method of evaluation. In support of above finding the learned CIT (Appeals) relied upon para 1.42 of OECD Guidelines. It was accordingly held that stand taken by TPO in treating assembly and distribution as separate business se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,056 12,595 -------------------------------------------------- 93.4 The learned CIT (Appeals) did not record any finding on above claim but noted further submissions of the appellant and rejected them, with the following observations: "In this regard, the AR submitted that the pricing of the products has to be competitive and has to take the overhead costs of the export transaction into account. For instance, freight is disproportionately large in the export of consumer electronic products since the value/volume ratio in case of such products is usually very low. Further, the appellant received export benefits under the DEPB to engage in the export sales. Taking into account such factors, the export prices would be more beneficial than the price fetched by the same product in the domestic market. (v) The ld. AR further submitted that it operated in a "limited risk" environment. In the absence of comparable companies operating under similar circumstances, i.e., marginal costs, the appellant has chosen full fledged manufacturers of consumer electronics as comparables. Since a full fledged manufacturer operating under uncontrolled environment would normally undertake more ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ------------- Particulars Amount in Relief allowed Rs.('000) by CIT(A) -------------------------------------------------------------- Service Revenue 9,192 9,192 -------------------------------------------------------------- Scrap Sale 4,130 4,130 -------------------------------------------------------------- Rebate Received 5,184 5,184 -------------------------------------------------------------- Provision W/Back 5,702 Nil -------------------------------------------------------------- Balances written back 3,548 Nil -------------------------------------------------------------- Insurance claim received 1,772 Nil -------------------------------------------------------------- Reimbursement against defective CRTs 2,071 2,071 -------------------------------------------------------------- Interest Received from customers for delayed payment 1,631 Nil -------------------------------------------------------- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... duty and working capital, the learned CIT(Appeals) held that no specific working showing distinction between the appellant and other comparables was filed before him. Hence no other adjustment was required. The claim was rejected. 94.5 Some other claims were considered in para 25.3 of the impugned order discussed hereinafter. As regards adjustments under proviso to section 92C(2) of Income-tax Act, the ld. CIT(A) observed as under:- Adjustment in arithmetical mean under proviso to section 92C(2): 95. As regards claim under proviso to section 92C(2), the learned CIT (Appeals) held that the benefit of variation of +/- 5 per cent was available only in those cases where the transfer pricing shown by the taxpayer was within +/- range of 5 per cent. If the transfer pricing shown by the appellant was beyond the above range then no benefit under the proviso was to be allowed. For above view, he relied upon order of his predecessor CIT(A) in the case of M/s. Mentor Graphics (Noida) (P.) Ltd. dated 30-3-2006. Enhancement of income: In para 25 of the impugned order, the learned CIT (Appeals) discussed the question of reduction of 20 per cent allowed by TPO on account of difference in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yer and by applying TNMM tried to justify acquisition at arm's length price. However in course of proceedings before the TPO the Taxpayer agreed to take itself as a tested party and application of TNMM for TP analysis. Filter applied by TPO were also more or less accepted. Certain specific issues relating to inclusion and exclusion of certain items of income and expenditure or entities have been raised here by the parties. We would deal with the issues raised before us. The first relates to exclusion of advertisement reimbursement from taxpayer's AE 'Sony Marketing Asia Pacific Pte. Ltd.' (Sony Pacific) as not forming part of operating profit. 97.1 The taxpayer as part of market penetration strategy incurred advertisement expenditure in India. With a view to sustain aggressive marketing activities on year-to-year basis, taxpayer entered into an Advertisement Contribution Agreement ("Agreement") dated April 1, 2001 with "Sony Pacific" whereby the latter undertook to reimburse 50 per cent of expenditure incurred by the appellant subject to maximum of US$ 29,50,000 by way of advertisement and sales promotion of Sony products in India. Copy of the Agreement is available at pages 299A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e routine operational expenses and were in no way dependent on the reimbursement. 99. In appellate proceedings before us, the ld. Representative reiterated the submissions advanced before the revenue authorities. These are discussed herein after in detail. 99.1 The learned Departmental Representative before the Appellate Tribunal submitted that the reimbursement was not part of operating expenses. She denied that TPO had conceded in favour of the taxpayer as contended on behalf of the taxpayer. The reimbursement was like subsidy received from AEs. The learned D.R. in her arguments further emphasized that transfer-pricing analysis has nothing to do with accounting treatment of the item for taxation or matching principles e.g., interest receipt is included in business income but is not operating expenditure. She placed strong reliance on the orders of the revenue authorities and contended that reimbursement was a sort of subsidy or grant from the associated concern and cannot form part of operating income. Source of funding was immaterial. 100. We have taken into account above objection of the revenue authorities and the learned D.R. We have also considered forceful arguments n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxing statute has to be applied in accordance with the legal rights of the parties to the transaction. When the transaction is embodied in a document the liability to tax depends upon the meaning and content of the language used in accordance with the ordinary rules of construction." 100.2 In the case of CIT v. Gillanders Arbuthnot Co. [1973] 87 ITR 407 (SC) their Lordship observed at page 418 of the report, as under: "that it is now well-settled that the taxing authorities are not entitled, in determining whether a receipt is liable to be taxed, to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as "the substance of the matter". The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authority to unravel the device and to determine the true character of the relationship. But, the legal effect of a transaction cannot be displaced by probing into the "substance of the transaction". This principle applies alike to cases in which the legal relation is re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... actually incurred which shall not exceed US $2,950,000. (ii) The Agreement further lays down certain conditions which the taxpayer has to meet in order to receive reimbursement amount. The claim for reimbursement is to be made by the taxpayer in writing within 30 days following the last day of the relevant period. The taxpayer has to submit the claim to the payer with documentary evidence as provided in Article 4 of the agreement which includes full description of sale promotion activities carried, details of cost and expenses, copies of publication and other details of advertisement carried, copies of invoices etc. (iii) Sony Pacific is to make payment within 60 days of receipt of the claim. As noted earlier, there is no allegation or dispute that the agreement was intended to serve some purpose other than the one stated in the agreement or said purpose of business was not achieved. (iv) There is further no dispute that advertisement expenses in the line of business, with which we are concerned, are operating expenses and which in the case in hand were incurred wholly and exclusively for the purposes of the business. This fact is admitted by the TPO as is evident from para ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpanies. It is specifically provided that Sony Pacific would pay 50 per cent of cost and expenses incurred by the taxpayer. It is a matter of common knowledge that advertisement carried on TV and other media have worldwide effect and multinational companies enter into such cross border arrangements. Such special circumstances, as would entitle the revenue to disregard and treat the reimbursement as inconsistent with economic realities of transaction, have not been brought on record. It is not material that other comparables have not entered into similar arrangements. Business necessity of entering into the agreement by the taxpayer has been fully explained. On facts we are unable to disregard the assertion of the taxpayer that it would not have incurred such huge expenses on advertisement but for agreement of reimbursement. We do not see any good ground for not accepting this reimbursement as part of normal operating profit of the taxpayer. Accordingly, the revenue authorities are directed to include reimbursement as part of operating income of the taxpayer. We allow this ground of appeal. 105. We next take ground No. 8.3(d) where exclusion of reimbursement received from Sony Gul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payer. We also find force in the contention of the learned representative of the taxpayer that revenue authorities are not justified in disregarding the matching principles. Having regard to purpose of the expenditure and to the extent expenses were for the benefit of Sony Gulf, the reimbursement received from the AE was to be treated as part of operating cost/profit of the taxpayer. Amount could not be excluded. Accordingly, we hold that exclusion of INR 48,31,840 on facts and circumstances of the case was not justified. Exclusion of other amounts credited in P L Account 106. The TPO while computing operating profits of the taxpayer, has excluded some more items as discussed in para 4 above but on appeal, the CIT(A) accepted the contention of the taxpayer and allowed relief on five items (shown in chart in para 11 above) and took them as part of operating profit. The revenue has not challenged above action of the ld. CIT(A). We therefore, proceed to consider the items which still remain excluded for computing operating profit. 106.1 The first of these items is, provision written back amounting to Rs. 57,02,000. For exclusion of above item and for balances written back, inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lity provided may become barred by limitation or for some other reasons, liability gets unenforceable or is reduced or ceases to exist with the passage of time. Therefore it may be necessary to write back such a liability. But it cannot follow that the liability was not expenditure of business or operating expense. Cessation of a liability is a taxable income under section 41 of the Income-tax Act. The underlying principle behind above provision is that revenue takes back a benefit which it granted earlier, but which, due to subsequent events or changed circumstances should be charged to tax as "income". Statutory provision overrides general understanding that mere creation of a benefit to a taxpayer by admission or cessation of a debt or a liability should not result in an income. Thus, creation of unpaid liability and its write back is a normal incident of a business operation which is carried everywhere in accounts to have true picture of profits of the relevant period. If a liability has ceased to exist and is required to be accounted for and shown as income by the taxpayer and, in case it is not so shown the taxpayer can be subjected to a penal action under Indian regulations. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uffered by the taxpayer company during its day-to-day operations such as during transit of goods and due to pilferage etc. Such losses and compensation in our view are directly connected to the operations and are accounted for in routine. It is not shown that damages were received for any capital or non-business asset. Damages received from insurance, in our considered opinion do not have and cannot be treated differently from the price of the goods realized from the customers. Therefore, there is no question of excluding insurance claims while computing operating profit of the taxpayer. 109. The next item relates to interest received from customers for delayed payment. On facts and circumstances of the case, we see no good ground for excluding interest received from customers for delayed payment as not forming part of the operating profit of the taxpayer. In the case of CIT v. Govinda Choudhury Sons [1993] 203 ITR 881, their Lordships of Supreme Court on interest similarly received have observed as under:- "If the amounts are not paid at the proper time and interest is awarded or paid for such delay, such interest is only an accretion to the taxpayer's receipts from the cont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ces, we are unable to interfere on this issue. The ground is rejected. Sale of CTV to Sony Japan 111. The next ground relates to addition on account of sale of colour TVs to Sony Japan. 111.1 During the year under consideration, the taxpayer sold 8680 units colour TV (Type 21" Flat screen WEGA CTV Model KV-XA 21 P80) at the rate of Rs. 9,964.65 each unit. The TPO found that the TVs with minor variant of Model 21 WEGA were also sold to domestic dealers. The sale price of above models was furnished by the taxpayer and is noted by the TPO in para 12.3 page 17 of his order. It ranges between Rs. 17,000 to Rs. 20,000. The TPO further found that in its T.P. report and by relying on TNMM, the taxpayer had worked operating profit margin over total cost at 5.25 per cent (Arithmetic Mean of 2000-01) for the comparables as against operating margin of 5.38 per cent claimed by the taxpayer. The TPO held that profit margin at the rate of 5.38 per cent was incorrectly taken by the taxpayer. He further held that the profit margin shown by the taxpayer was gross margin in which direct expenses like wages, depreciation, power and fuel were excluded. The taxpayer was, therefore, asked to expl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nit -------------------------------------------------- Sales Value 16,138 10,674 -------------------------------------------------- Less: Excise duty @ 16% 1,929 -------------------------------------------------- Less: Sales tax @ 14% 2,010 -------------------------------------------------- Less: Other taxes @ 1 % 144 -------------------------------------------------- Add: Export benefit @ 18% 1,921 -------------------------------------------------- Comparative prices 12,056 12,595 -------------------------------------------------- 111.4 The learned CIT (Appeals) recorded no finding on above alternative claim. He noted further submissions of the appellant but found no force in them with the observations already noted in para 10.4 of this order. 112. The taxpayer is aggrieved and has brought the issue in appeal before the Appellate Tribunal. It was reiterated that TVs exported to Sony Japan were assembled to utilize idle assembling facilities of the taxpayer. It was submitted that the TPO went wrong in not considering arguments which could not be taken in the transfer pricing documents. Alternatively, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der the fact of under-utilization of capacity as a factor relevant to the determination of arm's length price in relation to the export of TVs to AE. No documents at any stage have been produced to substantiate this claim, yet it is expected that this contention would be treated with seriousness. (b) The functions, assets and risks analysis contained in the TP report in pages 17-19, Vol. 1 of the paper-book clearly states that the manufacture of CTVs for the purposes of export to AEs is a clear well thought part of the overall supply chain strategy. In fact, the manufacture is based on strict scheduling and budgeting by the AEs in this regard. Moreover, the report manifestly admits that the price is based on negotiations and the taxpayer is exposed to price/market risk. (c) The numbers of TVs exported is 8680. This figure is not a rounded off figure. It shows a conscious purchase by the AE, not a random usage if idle lying capacity. (d) The costing proposed by exported TV is wrong. Fuel, raw material and power expenses cannot be excluded from costing, as is being proposed by taxpayer. These expenses were not occurring in "idol capacity"." 113. We have given careful thought ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14. In the revenue's appeal for the assessment year 2002-03, there is challenge to the deletion of Local Area Development Tax (LADT). 114.1 The TPO, while working out operating margin of profit, excluded expenses of INR 11.61 crores debited in the account for payment to Haryana Government as Local Area Development Tax (LADT). The TPO did not agree to the taxpayer's contention that similar tax was not being paid by other comparables. The same contention was reiterated before the CIT(A) in appeal who held that taxpayer was required to be placed on equal footing with comparables while calculating the margin of profit. Since such type of payment was not involved in cases of other comparables, the ld. CIT (Appeals) saw justification to direct to exclude Rs. 11.61 crores paid as LADT and then calculate the profit margin. 114.2 The revenue is aggrieved on account of above directions of the ld. CIT(A) and has brought the issue in appeal before the Appellate Tribunal. She submitted that this issue was not raised before TPO and therefore, the ld. CIT(A) should not have permitted to raise it. The ld. DR submitted that local development tax was an operational levy and not a difference need ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the TPO for assessment year 2002-03 viz., B.S. Refrigerators Ltd., Videocon Appliances Ltd. and Videocon Communication Ltd., no arguments were advanced on behalf of the taxpayer raising any objections about selection/inclusion of the said comparables. It was, however, noticed during the course of dictation/deliberation that a statement has been placed in the paper book filed by the taxpayer giving comparative FAR analysis of these companies selected as comparables. In order to seek clarification about the exact stand of the taxpayer on this issue, the case was fixed for hearing on 11-9-2008. The exact position which transpired during the course of hearing so fixed was recorded in the order sheet entry as under:- "Present for the taxpayer - Shri Mukesh Bhutani, CA. Present for the Department - Smt. Himalini Kashyap, CIT-DR. First clarification sought from Shri Bhutani is about the companies to be included as comparables. He replies that Hitachi, Godrej, Carrier Whirlpool are sought to be included for assessment year 2002-03. As regards exclusion, he submits that Videocon International alone is sought to be excluded as comparable in assessment year 2002-03. Regarding ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and Rs. 40.3 crores respectively. 115.3 On careful consideration of rival submissions, we see no justification for excluding above named three entities from the list of comparable for working out mean operating profit. It is an admitted position that these companies satisfy screening criteria (filters) adopted by the Transfer Pricing Officer at page 10 of the order except his observation that companies were having controlled transactions with related parties. The TPO and on appeal, the learned CIT (Appeals) did not substantiate the allegation by furnishing figures of controlled transactions to show that such transaction had significant impact on the profits of these companies. The taxpayer, on the other hand, has given percentage of transaction with related parties and we are of view that they are not so high as to exclude them from the list of comparables. We are further of view that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15 per cent of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Godrej. The revenue authorities were wrong in taking only high profit companies and excluding loss making companies for purposes of comparison. In the like manner DR's argument that if loss making companies are accepted as comparable then entire purpose of Transfer Pricing Regulation would be defeated is untenable. Further emphasis of DR on the Annual Report of the company for financial year 200 102 relating to future outlook and framework of initiatives, company intended to reduce cost and improve its efficiency, was stated by Shri Bhutani to be irrelevant. The Annual Report of Godrej referred to above states like this: "The Company's performance during the year under review reflected the general state of the refrigerator industry and washing machine industry, which recorded negative growth. The market situation, already over-crowded with too many players, resulted in fierce price-cutting, heavy advertisement spend, new product launches and easy credit terms in an attempt to boost consumer sales." 118. The learned counsel for the taxpayer tried to meet above objection by stating that harsh industry conditions such as competition, price cuttings, heavy ad spending etc. wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enture of the company stands terminated. All this is admitted in the official report of Godrej. Besides, it is also carrying on related party transactions. Each of above factors which is considered and highlighted in the annual report, may not have a significant effect, if taken singly. However, when cumulative effect of all the factors is considered, one gets a totally different picture. It has therefore to be held that Godrej was rightly excluded from the list of the comparables. We concur with the view taken by the revenue authorities and reject all the arguments advanced by learned counsel for the taxpayer. This ground of appeal is rejected. Objection on inclusion of Videocon International 120. To support exclusion of above company, the learned counsel for the taxpayer Shri Bhutani argued that material available on record clearly shows that Videocon International is carrying full-fledged manufacturing activities as against mere assembly of TVs with imported components carried by the taxpayer. Revenue authorities further ignored that Videocon International enjoys cost benefits due to backward integration and indigenous manufacturing of components as reflected in the compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as held as under: "24. It is true that "transfer pricing" is not an exact science, evaluation of transactions through which the process of determination is carried in an art where mathematical certainty is indeed not possible and some approximation cannot be ruled out, yet it has to be shown that analysis carried was "judicial" and was done after taking into account all the relevant facts and circumstances of the case. Minimum requirement is to prima facie show that controlled international transaction was properly examined, comparable and arm's length price fixed objectively, honestly and in a bona fide manner as required by the statutory regulations. The requirement of the statutory regulation has been thoroughly discussed by the Appellate Tribunal in the case of Aztech Software, but in order to dispose of this appeal, these are reiterated here:- 25. The comparability of an international transaction i.e., uncontrolled transaction and a controlled transaction is to be judged under rule 10B(2) with reference to the following, namely: (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction." As noted in the case of Aztech Software "rarely one is able to locate an identical uncontrolled transaction". The Arm's Length Price is determined by taking result of a comparable transaction in comparable circumstances and by making suitable adjustments for the differences. 26. The first step in the determination of Arm's Length Price is to analyse the specific characteristics of the controlled transaction whether it relates to transfer of goods, services or intangible. Without proper study of specific characteristics of controlled transaction, no meaningful comparison or location of comparable is possible. For example, a mere consideration that controlled transaction relates ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble identified are not correct as appropriated adjustments for differences in such cases are not possible. Therefore, while performing searches for potential comparable companies, not only turnover and operating profit but functions performed and risk profile are also to be considered. However, it can always be shown on the given facts of the case that comparable found are similar or almost similar to the controlled transaction and no adjustments are needed. It is useful to see the level of intangible assets in comparable to an appropriate base. Depending on facts of the case, final set of comparables may need to eliminate differences by making adjustments for the following: (a) working capital (b) adjustment for risk and growth (c) adjustment of R D expenses 27.1 The risk not only due to human resources, infrastructure and quality which are normally taken into account yet more significant risks like market risk, contract risk, credit and collection risk and risk of infringement of intellectual property are being ignored here. In most of the comparable analysis carried in India, the latter type of risk are not being taken into consideration although these can lead to major ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e adjustment should be made to account for the differences that affect the net margin. The U.S. Regulations also call for similar adjustments to account for any differences that would materially affect profits under the chosen profit level indicator. The learned Author concedes that judgments about what effects are "material" and what "adjustment" should be made on account of those effects, tend to be highly subjective. The learned author has further stated as under with reference to para 3.42 of GECD Guidelines and U.S. Treas. Regulation 1.482-5(d)(3)(iii): "The DECD Guidelines also state that it would be inappropriate to apply TNMM on a company-wide basis: if the company engages in a variety of different controlled transactions that cannot be appropriately compared on a aggregate basis with those of an independent enterprise. Similarly, when analyzing the transactions between independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. (DECD Guidelines para 3.42). This statement is sometimes interpreted as prohibiting the company-wide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elines for Multinational Enterprises and Tax Administrators", 1995 states as under: "in dealings between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in determining whether controlled and uncontrolled transactions or entities are comparable, comparison of the functions taken on by the parties is necessary." 126. In the case of Videocon International, apart from the fact that its turnover is five times more than that of the taxpayer in the relevant period it has valuable intangibles and R D unit which was not held and possessed by the taxpayer in the relevant period. The notes of annual report of Videocon International for the year 2000-01, mentions that the company manufactures glass shell Panels for colour T.V. Picture tubes, CRT Display/Video Display units, Monitors and Funnels for CTV Picture tubes. At page 6 of the Annual Report, under the heading "Expansion of Glass Shell Unit", it has been mentioned that: "Your company is the only leading manufacturer of glass parts required for its manufacture of picture tubes." At para 1.2 on page 13 under Mana ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e taxpayer. In fact enterprises buying components from VIL and then assembling them to make TV for sale in the market are enterprises comparable to the taxpayer as those units (enterprise) are carrying on similar functions as are carried by the taxpayer and not VIL. In our considered opinion, Transfer Pricing Officer and on appeal CIT (Appeals) was not correct in not taking into account the huge difference between the size of VIL and taxpayer, differences in the turnover, differences in the assets, differences in the functions performed and risk undertaken by the taxpayer and the VIL. In our considered opinion, above differences materially affecting the performance of the enterprise could not be reasonably accurately evaluated for making suitable adjustments. Therefore, it would only be right to exclude Videocon International from the list of comparison. We direct accordingly. 127. We are also not impressed by the arguments of learned Departmental Representative that Videocon International was included in the list of comparables furnished by the taxpayer. In our considered opinion, there is sufficient material on record to show that taxpayer in proceedings before the TPO as well ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year 2002-03. 129.2 In the next year, the learned CIT (Appeals) attention was drawn to provisions of rule 10B(3) and appellant's submission that adjustment must be made on account of difference in working capital of the appellant and other comparables. The taxpayer further claimed adjustment for the difference in terms of the sale and purchases. Taxpayer also sought inventory adjustment as its money was tied up in holding inventory which is an operating expense in an economic sense. Detailed computation of working capital carried by the appellant was claimed to have been submitted before the Assessing Officer. The appellant further sought adjustment for the risk by contending that appellant was a low end assembler and functions performed by it were comparatively lesser than the functions performed by the comparables. The appellant was dealing with AEs for procuring important components whereas comparables were required to deal with outsiders, maintain quality control and carry negotiations. For all the above factors, risk was involved for which comparables were getting returns. Therefore, adjustments were necessary for the risks stated above. 129.3 The learned CIT (Appeals) qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T (Appeals) has allowed 10 per cent adjustment for R D functions while adjustment for ownership of intangibles and risk etc. were denied. It was contended that learned DR's argument that appellant has to bear higher price/market risk, than the comparable, is without any valid finding or facts. Taxpayer's participation in the determination of price while dealing with AEs is quite restricted. This was also immaterial as ALP is to be taken into consideration based on independent transaction and third party. Market risk arises when enterprise is subject to adverse sale conditions due to increase in competition in market place, adverse demand conditions or of inability to develop market or position product to service targeted customer. It was urged that comparable companies operating in the same market bear much higher risk than the appellant. These comparables are also responsible for storage and subsequent sale of finished goods and bear the risk of obsolescence/damage of its inventory. The learned representative of the taxpayer also challenged the finding of learned CIT (Appeals) that appellant had to pay no consideration towards intangibles. In fact above finding was irrelevant. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessment year 2002-03 allowing deduction at 20 per cent was fair and reasonable and should be upheld. 133. As regards the adjustment sought by the taxpayer on account of working capital, it is observed that the same was not allowed by the authorities below on the ground that the required details in this regard were not furnished by the taxpayer. Before us, the learned counsel for the taxpayer has submitted that such details were very much furnished by the taxpayer before the authorities below. In this connection, he has invited our attention to the copy of statement placed at page No. 367 giving such details which have been perused by us. 134. It is no doubt true that as per the OECD Guidelines, the adjustment on account of working capital is required to be made to the operating margins of the comparables selected and even the Tribunal in the case of Mentor Graphics (Noida) (P.) Ltd. has accepted this proposition in principle. The question, however, is whether in the facts and circumstances of the present case, any such adjustment would be justified on account of working capital to the operating margins of the comparables. In this regard, it is observed on perusal of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tment to the operating margins of the comparables on account of higher amount of custom duty paid on imported components viz.-a-viz. the comparables, it is noticed that the working of such adjustment sought by the taxpayer is given on page Nos. 365 and 366 of the taxpayer's paper book. A perusal of the said working shows that it is mainly based on proportion of imported components and the duty paid on such imported components. In our opinion, this basis adopted by the taxpayer for seeking the adjustment on account of excess custom duty borne by it is not correct inasmuch as consideration of duty payment alone would not justify such adjustment and it would be necessary to take into account the cost of components imported along with the custom duty paid thereon for the purpose of comparison with the corresponding indigenous components consumed by the com parables. Moreover, the local levies such as sales tax etc. are also required to be taken into account for such comparison. It is also pertinent to note here that if the taxpayer company has purchased the imported components after payment of custom duty at a higher price than the indigenous components purchased by the comparables, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in its appeal for assessment year 2003-04 relates to the transfer pricing issue which is being considered separately along with the relevant grounds raised by the taxpayer relating to the same issue while disposing of the appeal of the taxpayer. ITA No. 820/Delhi/2007-Taxpayer's appeal for AY 2003-04 142. Ground No. 1 raised by the taxpayer in its appeal is general requiring no adjudication from us. 143. As regards the issue raised by the taxpayer in ground No. 2 relating to the taxpayer's claim for deduction under section 80-IA in respect of miscellaneous income and service income, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 2 of the taxpayer's appeal for assessment year 2001-02 being ITA No. 1189/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) disallowing the taxpayer's claim for deduction under section 80-IA in respect of miscellaneous income and service income and dismiss ground No. 2 of the taxpayer's appeal. 144. As regards the issue raised by the taxpayer in ground No. 3 relating to the disallowance made on account o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onsider the same on merits and decide this issue afresh in accordance with law. Ground No. 4 of the taxpayer's appeal is accordingly treated as partly allowed. Transfer Pricing Issues involved in AY 2003-04 147. Ground Nos. 5 to 10 raised in the taxpayer's appeal and ground No. 4 raised in the revenue's appeal involve issues relating to transfer pricing and pertain to the addition made by way of "adjustments" under section 92CA of the Act by determining higher arm's length price than disclosed by the taxpayer in the international transactions carried with its associated enterprises "AEs". 148. The taxpayer in its appeal for assessment year 2003-04, as far as transfer pricing is concerned, has raised the following grounds of appeal:- "5. That on facts and in law the CIT(A) failed to adjudicate on ground No. 16 taken in the Memorandum of Appeal before him regarding the argument that the Assessing Officer had only mechanically followed the order passed by the TPO without any application of mind on his part. The said ground reads as under:- 'That on the facts and circumstances of the case, the ld. Assessing Officer has erred by relying on the order passed by the ld. TPO witho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... djustment did not tantamount to production of additional evidence as stipulated by rule 46A. 9.9 Observing in Para 21.3 of the impugned order that the following items while calculating the operating margins for comparison and determination of ALP be excluded:- -------------------------------------------------------- Particulars Amount in Rs. ('000) -------------------------------------------------------- Provisions written back 7,916 -------------------------------------------------------- Sales Tax/Service Tax refund 431 -------------------------------------------------------- Notice Pay Recd./Fines Penalties from staff 437 -------------------------------------------------------- Membership Subscription received 35 -------------------------------------------------------- Other misc. income 12,162 -------------------------------------------------------- 9.10 Concluding in para 21.3 of the impugned order that miscellaneous income is non-operating since exact constitution of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year under consideration also. The ground of appeal of the revenue is accordingly rejected. 151. The taxpayer in the assessment year under consideration, like in assessment year 2002-03, has raised several grounds. However, during the course of oral arguments as also in the written submissions filed by the taxpayers, certain specific issues are/were raised. These issues are dealt with herein below. Exclusion of reimbursement of advertisement expenses 152. In the period under consideration, like in assessment year 2002-03, the TPO has excluded reimbursement of Rs. 10.31 crores received by taxpayer from its AE Soni Marketing Asia Pacific (Sony Pacific) to meet part of the expenses incurred on advertising and sale promotion. The submissions of the parties in respect of this claim were the same as advanced and fully discussed in the order for assessment year 2002-03. For the reasons already recorded, we hold that expenditure incurred by the taxpayer on advertisement and sale promotion were incurred to benefit its AE also and as per commitment of the AE to reimburse part of the expenditure. Therefore, the taxpayer debited net of reimbursement expenditure to the Profit and loss ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e impugned order of CIT(A) are as under:- -------------------------------------------------------- Particulars Amount in Rs. ('000) -------------------------------------------------------- Service Income 7,824 -------------------------------------------------------- Scrap sales 5,263 -------------------------------------------------------- Spares Sales 1,442 -------------------------------------------------------- Damages for defective items 1,216 -------------------------------------------------------- Insurance Claim 14,721 -------------------------------------------------------- Provisions written back 7,916 -------------------------------------------------------- Sales Tax/Service Tax Refund 431 -------------------------------------------------------- Notice Pay Recd./Fines Penalties from Staff 437 -------------------------------------------------------- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lusions for computing operating profit. We order accordingly. 154.1 So far as other items like exclusion of sale tax refund/service tax refund, notice pay received/fine and penalties from staff and miscellaneous income are concerned, no detailed submissions were made except stating that claim made before the ld. CIT(A) be considered here too. The taxpayer has submitted certain arguments while making similar claim in the general grounds relating to deduction under section 80HHC. Reliance in support of such claim has been placed on the decision of Hon'ble Bombay High Court in the case of Bangalore Clothing Co. wherein certain guidelines have been laid down to ascertain as to whether any item of other income represents operational income of the taxpayer. Applying the said guidelines, we have held that scrap sales, spare sales and provisions written back represent operational income of the taxpayer. Similarly, we are of the view that the receipts from damages for defective items, insurance claim and sales taxi service tax refunds can reasonably be treated as operational income of the taxpayer applying the said guidelines and accordingly, the same can be included in working out its op ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2-03. The facts and circumstances in the year under consideration are quite identical and no distinguishing feature has been pointed out to exclude above companies in the year under consideration. Here, it may be relevant to point out that Hitachi after showing losses for some years have shown profit as per its annual account available to public in the financial year 2004-05. Therefore, in our opinion Hitachi could not be excluded merely because it had shown loss in certain years. Above companies were accepted to have satisfied all the filters except that of transactions with the related parties. This objection of the revenue has been thoroughly considered in assessment year 2002-03 and above mentioned companies have been included in the list of comparables. As facts and circumstances are similar and as transactions with the related parties, like the last year, are not likely to affect operating profit materially, these companies are included in the list of comparables this year also. 155.2 The taxpayer has again contended that Godrej Appliances Ltd. be included and Videocon International be excluded from the list of com parables in the light of directions of OECD guidelines and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic mean of more than one price determined by the Most Appropriate Method. As the taxpayer was not falling in above range, it was not entitled to any benefit. 159. The taxpayer carried the matter in appeal before the ld. CIT(A). It was contended that proviso to section 92C is to be read along with provision of section 92C(4). The representative of the taxpayer also drew CIT(A)'s attention to notes on clauses of the Finance Bill, 2002 wherein this provision has been explained. 159.1 It was accordingly contended that the taxpayer has the option of charging a price to its associated enterprise which may vary from the arithmetic mean of uncontrolled price determined by the TPO by +/- 5 per cent. Thus, adjustment to the income of the appellant should have been made after considering +/- 5 per cent variation from determined Arm's Length Price. It was further submitted that it is mandatory for the TPO to calculate the Arm's Length Price in the light of sub-section (1) and sub-section (2) of section 92C of the Income-tax Act. 160. After considering facts and circumstances of the case, the ld. CIT(A) found no force in the submissions advanced on behalf of the taxpayer. He was of the vi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd arithmetic mean of Arm's Length Price determined by the Assessing Officer, the CIT(A) further added. According to the ld. CIT(A), such a view cannot be accepted. Reliance was placed by the ld. CIT(A) on the decision taken by his predecessor in the case of Mentor Graphics (Noida) (P.) Ltd. for assessment year 2002-03 where similar claim was rejected. Turning to the facts involved in two assessment years under appeal, the ld. CIT(A) found that arithmetic mean of ALP determined by the TPO in both the assessment years exceeded range of +/- 5 per cent from the international transaction shown in the books of account. The appellant was not entitled to any relief under the above proviso. The ld. CIT(A) accordingly upheld the action of the Assessing Officer. 162. The taxpayer being aggrieved has brought the issue in appeal before the Tribunal. During the course of hearing, ld. Representative of the taxpayer has made the following submissions:- "(i) Circular 12/2001 states that "The Assessing Officer shall not make any adjustment to the arm s length price determined by the taxpayer, if such price is up to 5 per cent less or up to 5 per cent more than the price determined by the Assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -------------- Declared Transfer Price 90 90 (Sale) ------------------------------------------------------ Mean ALP 100 100 ------------------------------------------------------ +/- 5% Range 95-105 95-105 ------------------------------------------------------ Adjusted Mean ALP (-5%) 95 95 ------------------------------------------------------ ALP 95 95 ------------------------------------------------------ TP Adjustment 05 (95-90) 10(100-90) ------------------------------------------------------ In the above example, the declared transfer price of 90 is outside +/- 5 per cent range of 95-105. Therefore, the TPO takes mean ALP of 100 as ALP and consequently, transfer pricing adjustment (10) is made for the difference between mean ALP and transfer price (90). However, the taxpayer takes adjusted mean ALP of 95 as ALP and contends that transfer pricing adjustment should be made for 05 on account of difference between adjusted mean ALP (95) and transfer price (90)! In most of the transfer pricing audit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s length price determined by the Assessing Officer. Immediately thereafter, the Board issued the Circular No. 12, dated 23-8-2001 specifying that the Assessing Officer shall not make any adjustment to the price shown by the taxpayer if such price was up to 5 per cent less or up to 5 per cent more than the arm's length price determined by the Assessing Officer and in such cases, the price declared by the taxpayer may be accepted. In effect, the transfer price shown by the taxpayer was not to be disturbed if it was within +/- 5 per cent mean ALP range i.e., up to 5 per cent less (i.e. in case of receipts) or up to 5 per cent more (i.e., in case of outgoings) than the arm's length price determined by the Assessing Officer based on the arithmetical mean of the prices. If the transfer price shown by the taxpayer was less than 5 per cent (in case of receipts) or more than 5 per cent (in case of outgoings) of the arithmetical mean arm's length price (i.e., mean ALP) determined by the Assessing Officer, then the transfer price declared by the taxpayer was not to be accepted and the adjustment was required to be made for the difference between the arm's length price determined by the Assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and not the adjusted mean ALP. Consequently, the transfer pricing adjustment would be made for the difference between the transfer price shown by the taxpayer and the mean ALP determined by the TPO. The view taken by TPO with regard to +/- 5 per cent adjustment in ALP determination, as mentioned in preceding paragraphs is, thus, found to be in consonance with the legislative intent of the proviso to section 92C(2) of the Act." 163. We have given careful thought to the rival submissions of the parties. We are of the view that Circular No. 12, dated 23-1-2001 does not help to solve the problem. The said Circular was issued prior to introduction of the proviso. It was meant to give benefit to the marginal cases in the initial years of implementation of Transfer Pricing Regulations in India. The proviso, on the other hand, is a permanent provision. It is intended to provide safe harbour to marginal cases falling within the range. However, it is a settled law that when a provision is introduced, the courts have to look at the language in which the provision is expressed. Only in cases of ambiguity, it is permitted to go beyond the language arid consider the intention of the legislati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contention that the second part/limb of the provision is meant to cover marginal cases only where the price shown by the taxpayer does not exceed 5 per cent of the Arm's Length Price representing arithmetic mean by the Most Appropriate Method. Where the difference is much more than 5 per cent, then taxpayer cannot have the benefit of the said provision, particularly where the taxpayer has not accepted such arithmetic mean. 163.4 The other view is the one accepted by Kolkata 'A' Bench of the Tribunal in the case of Development Consultants (P.) Ltd. As per the said decision, the benefit of second limb of the proviso was allowed to the taxpayers although the price disclosed by it was more than 5 per cent of arithmetic mean. The decision of the Co-ordinate Bench is binding on us and we are inclined to follow the same. That apart, we are of the view that Kolkata Bench of the Tribunal has taken a right view of the provision. We are to go by the language of the provision and when we do so, we do not see anything in the language to restrict the application of the provision only to marginal cases where price disclosed by the taxpayer does not exceed 5 per cent of the arithmetic mean. In ..... X X X X Extracts X X X X X X X X Extracts X X X X
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