TMI Blog2021 (9) TMI 12X X X X Extracts X X X X X X X X Extracts X X X X ..... prior to completion of ten years, how the provision is reduced on year to year basis, is also not explained. Before us, no explanation was offered as regards how the provision of ₹ 46,60,033 is arrived at. - the assessee has to prove before the A.O. the scientific basis for creating a provision - Ground restored to the files of the A.O. with the above directions. Allowable business expenditure or not - addition u/s. 37 being the expenditure related to construction of school at Bidadi, promotion of Japanese language and construction of basic civil structure for water purification plant at Ramanagaram - HELD THAT:- Majority of the expenses incurred by the assessee is incurred in villages very near to assessee's manufacturing plant. It is the claim of the assessee that the workers and their family has benefitted from the above expenditure. This fact has also accepted by the CIT(A) by allowing as deduction 10% of the total expenditure - Amount expended for promotion of Japanese language will also ultimately benefit the employees of the assessee. Taking the overall view and to put a quietus to the issue, we hold that 30% of the total expenditure would have benefitted the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - HELD THAT:- The assessee has reversed the provision which were no longer required. In the year of creation of this provision, the same were treated as operating in nature and reversal of the same should also be treated as operating in nature. This view has been consistently held by the judicial pronouncements relied by the CIT(A). Working capital adjustment - HELD THAT:- The working capital adjustment is an accepted adjustment - we hold that the CIT(A) is justified in directing the AO to grant working capital adjustment. TP adjustment should be restricted to AEs transactions - HELD THAT:- We hold that the CIT(A) has correctly directed the AO/TPO to restrict the TP adjustment to the AEs transaction. Royalty Benchmarking - assessee had adopted TNMM at the entity level in which process royalty payment is considered as closely linked transaction and part of operating cost - TPO rejected the above stand of the assessee and benchmarked the royalty transaction as per the ALP computation of assessment year 2012-2013 - HELD THAT:- We are of the view that once the net profit margin is tested on touchstone of arm's length price, it pre-supposes that the various components ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd exclusively for the purpose of business and are allowable. Grounds related to corporate tax (MTM Loss/Gain) 13. The learned CIT(A) has erred in confirming the action of the AO in: a. Disallowing a sum of ₹ 1,76,80,000/-, being mark to market loss on outstanding derivative contracts on the ground that same is notional loss. b. Not appreciating that such mark to market loss is in accordance with provisions of applicable Accounting Standard and allowable as deduction in the facts and circumstances of the case. We shall adjudicate the above issues ground-wise as under: Ground No. 11 3. The assessee is engaged in the business of manufacturing and selling of multi utility vehicles. For the relevant assessment year, the assessee had filed return of income by claiming deduction for provision towards long service benefit liability amounting to ₹ 46,60,033. The Assessing Officer disallowed the provision stating that such liability has neither crystallized nor accrued during the year. The Assessing Officer also stated that there was no contractual obligation on the assessee and such amount constituted loyalty bonus subject to section 192 at th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submitted that such an employee does not get a gold coin. 71. The appellant in the para no. 7.34 of the submission has claimed that in case of provision for employee long term service benefit liability, making of the company policy is the event which gives rise to the obligation. I do not agree with this claim. 72. I find that the liability to pay to an employee accrues on the day employee completes ten years in the organization and not before that. In my view the appellant can create a provision (which will be allowable under IT Act) on the completion of ten years by an employee and not before that. The appellant can make payment when the employee completes eleven years, twelve years, or even later. Meaning thereby that the provision which is created on the tenth year is allowable. Thus, expenditure becomes due during the previous year in which the employee completes ten years, irrespective of the fact whether it is paid during the previous year or not. The expenditure does not become due even one day before completion of ten years. 73. However, the appellant is creating provision for the employee who have completed one year, two years etc. by making some calculati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce benefit to its employees, then the recognition, measurement and disclosure requirements laid out under AS-15 is required to be adhered to. The liability in this case might arise on account of employees completing 10 years of service in future, is therefore, required to be quantified and recognized over a period of time in accordance with the Accounting Standards. Accrual is one of the fundamental accounting assumption. The term accrue is not defined in the Act. As per AS-1 (Disclosure of accounting policies), Accrual presupposes that the financial statements are prepared on mercantile system of accounting. Under this system, the effects of transaction and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in financial statements the period to which they relate. 3.4.2. The Hon'ble Supreme Court in the case of Bharat Earth Movers v. CIT [2000] 112 taxman 61 (SC) had held if business liability has definitely arisen in the accounting year, then the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What shou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gards the basis of arriving of the above stated provision. In simple terms, if the assessee had made a provision on proportionate basis, i.e., taking into account 10% on an year to year basis for gifting the memento on completion of 10 years of service, we could have understood the valuation report is based on some reasonable basis. Further, when the employee leaves the assessee-company prior to completion of ten years, how the provision is reduced on year to year basis, is also not explained. Before us, no explanation was offered as regards how the provision of ₹ 46,60,033 is arrived at. Therefore, in the facts of the given case, the assessee has to prove before the A.O. the scientific basis for creating a provision for ₹ 46,60,033. For this purpose, the issue raised in ground No. 11 is restored to the files of the A.O. with the above directions. It is ordered accordingly. 3.5. In the result, ground No. 11 is allowed for statistical purposes. Ground No. 12 4. The Assessing Officer had disallowed a sum of ₹ 73,91,476 u/s. 37 of the I.T. Act, being the expenditure related to construction of school at Bidadi, promotion of Japanese language and construct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... placed on record at pages 1094 to 1115 of the paper book filed by the assessee. The gist of the submission as regards expenditure incurred for improving Government School in Manchanayakanahalli Village, it was submitted that the expenses were for the purpose of business, for the following reasons:- (a) Help its employees' children in getting quality education facilities; (b) Ensure that its employees do not migrate in search of better educational facilities; (c) Uplift the morale of the employees and make them more productive; (d) Improve the brand image of Toyota in Manchanayakanahalli and nearby villages. 4.2. As regards the expenditure incurred for installation of water purification plant Byramangala Village, which is 2.5 kms. away, it was submitted that the construction of water purification plant would ultimately benefit assessee's employees and families in getting quality health and it ensure more efficiency at work. It was stated that the expenditure incurred for installation of water purification plant is wholly and exclusively for the purpose of business for the following reasons:- (a) Help its employees and their families in getting qua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for promotion of Japanese language will also ultimately benefit the employees of the assessee. Taking the overall view and to put a quietus to the issue, we hold that 30% of the total expenditure would have benefitted the employees of the assessee-company. Accordingly, we allow a sum of ₹ 22,17,441 out of the total expenditure of ₹ 73,91,476. It is ordered accordingly. 4.8. In the result, ground No. 12 is partly allowed. Ground No. 13 5. During the year under consideration, the assessee had planned to increase the overall capacity of the plant from 2,10,000 units to 3,10,000 units. The assessee, therefore, required funds to make investment in plant and machinery. The assessee approached bankers and availed Buyers Credit Loan facility from BTMU, Citi Bank and SCB Banks for investment in plant and machinery. The loan facility extended by BTMU, Citi Bank and SCB banks were denominated in Foreign Currency and the interest rate was benchmarked against LIBOR. To protect against fluctuations in foreign currency exchange rate and LIBOR, the assessee entered into hedge transaction with respective banks from whom it had borrowed under buyer's credit. The hedging ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion in the rate of exchange or whether the same could be allowed in the year of repayment of loans. In this regard, the Hon'ble Supreme Court has held that any difference i.e. loss of gain arising on conversion of the outstanding liability relating to forex transaction on revenue account at the end of the year should be recognized in the P L account for the reporting period. (ii) In view of this, it is clear that the Hon'ble Supreme Court has not adjudicated or decided the issue with respect to mark to market loss on forward contract. Therefore, this decision is not applicable to the facts of the case on hand. 7.7 Accordingly, in the light of the Board's instruction, it is held that the 'marked to market losses' claimed by the assessee on account of restatement of receivables at the end of the financial year on the basis of forward contracts are not allowable as revenue expenditure. Hence, the entire loss claimed by the assessee of ₹ 1,76,80,000 is disallowed and added back to the income of the assessee. 5.4. On further appeal, the CIT(A) confirmed the view taken by the Assessing Officer. The relevant finding of the CIT(A), reads as follow:- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as per the judgment of the Hon'ble Supreme Court relied on by the A.O. as well as the provisions of the Income-tax Act. As rightly pointed out by the CIT(A), the A.O. had in letter and spirit followed the judgment of the Hon'ble Supreme Court in the case of CIT v. Woodward Governor India P. Ltd. [ (2009) 312 ITR 254 (SC)], reiterated in the case of Oil and Natural Gas Corporation Ltd. v. CIT [ (2010) 322 ITR 180 and in the case of CIT v. Maruti Udyog Limited [ (2010) 320 ITR 729]. Further, underlying reason for availing the foreign loans are for purchase of plant and machinery, which is admittedly is on the capital front and cannot be allowed as a revenue expenditure. Therefore, the CIT(A)'s order confirming the assessment order on this issue is in accordance with law and no interference is called for. It is ordered accordingly. 5.8. In the result, ground No. 13 is dismissed. ITA No. 2016/Bang/2018 (Asst. Year 2013-14) (Revenue's appeal) 6. The grounds raised in Revenue's appeal read as follow:- 1. The order of the Ld. CIT(A) is opposed to law and facts of the case. 2. Whether CIT(A) is right in law in excluding M/s. Tata Motors Ltd. as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 2 - Inclusion of Tata Motors Limited 7. The assessee in its TP study, applied 25% RPT filter whereby companies having related party transactions (income transactions plus expenses transactions) in excess of 25% of sales were rejected as comparables. The assessee rejected Tata Motors Limited and Maruti Suzuki India Limited as comparable companies by holding that these companies was having RTP in excess of 25%. The TPO selected the above two companies as comparables. The TPO in his order relied on Tribunal's order in the case of Support Soft India for assessment year 2005-2006 in IT(TP)A No. 1372/Bang/2011. 7.1. Aggrieved, the assessee preferred an appeal to the first appellate authority. According to the assessee, TPO had applied 25% filter, but there is no discussion in the order passed u/s. 92CA of the I.T. Act whether the said filter has been applied by aggregating both income and expenses transactions or has been applied separately for both income and expenses transactions. The CIT(A) requested for remand report from the TPO. The TPO in his remand report dated 21.03.2018, computed RPT ratio of both Tata Motors Limited and Maruti Suzuki India Ltd. According the AR, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... calculated on an aggregate basis taking the ratio of RPT income plus RPT expenses by sales. The said position was adopted by the Revenue in the past years. In this regard, the TPOs order in assessee's own case for assessment year 2007-2008 has been placed on record. A perusal of the same it is clear that RPT ratio has been calculated taking both RPT income transactions plus RPT expenses transactions on aggregate basis. On the facts of this case, it is not clear how RPT ratio has been calculated for Tata Motors Limited vis- -vis other comparable companies. Therefore, this issue is restored to the files of the A.O. The A.O. is directed to calculate RPT ratio on an aggregate basis taking the ratio of RPT income plus RPT expenses by sales across the board for all the comparable companies (including Tata Motors Ltd. and Maruti Suzuki India Limited. 7.5. Therefore, ground No. 2 is allowed for statistical purposes. Ground Nos. 3 and 4 - Provision Written back - Operating in Nature 8. The assessee had written back provision of ₹ 18.48 crore that was no longer required. The same was credited to the profit and loss account. While computing the margin, the assessee trea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the submissions made before the Income Tax Authorities. 9.3. We have heard rival submissions and perused the material on record. The working capital adjustment is an accepted adjustment. In the following judicial pronouncements, it has been held that working capital adjustment has been provided for the purpose of better comparability. (a) Swiss Re Global Business Solutions India (P.) Ltd. v. DCIT [2020] 116 taxmann.com 716 (Bangalore - Tribunal) (b) Maxim India Integrated Circuit Design Pvt. Ltd. v. DCIT [IT(TP)A No. 1573/Bang/2017 dated 02.11.2020. 9.4. In view of the above judicial pronouncements, we hold that the CIT(A) is justified in directing the AO to grant working capital adjustment. It is ordered accordingly. 9.5. Therefore, ground Nos. 5 and 6 are allowed. Ground Nos. 7 and 8 - TP adjustment should be restricted to AEs transactions. 10. The assessee submitted before the AO/TPO that out of the total transactions which it had entered into, only 52.07% of the transactions are with its AEs, whereas, balance transactions are undertaken with third parties. The assessee requested the TPO to restrict the TP adjustment to only AEs transaction. The TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... issions made and filed a detailed objection against the analysis of TPO. The CIT(A) called for a remand report. In the remand report, the TPO rejected the claim of the assessee by referring to the order of the Tribunal in assessee's own case for assessment year 2005-2006. The assessee filed a rejoinder to the remand report. The CIT(A) partly allowed the ground of the assessee by holding that TPO has to follow consistent approach and should adopt net sales as denominator for the purpose of comparing royalty in case of comparables and the assessee. 11.2. Aggrieved, the Revenue has raised this issue before the Tribunal. The learned DR supported the order of AO/TPO. 11.3. The learned AR reiterated the submissions made before the Income Tax Authorities. 11.4. We have heard rival submissions and perused the material on record. The AO/TPO had made TP adjustment for shortfall in margins as well as royalty. The royalty adjustment has been made despite royalty being part of operating cost, although the royalty adjustment is held by the TPO as subsumed within the margin adjustment. We are of the view that once the net profit margin is tested on touchstone of arm's length pric ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -how/brand had not benefited the assessee and so the payment was not justified. This was reversed by the CIT(A) Tribunal on the ground that as the payment was genuine, the TPO could not question commercial expediency. On appeal by the department, the Hon'ble Delhi High Court held that the transfer pricing guidelines laid down by the OECD make it clear that barring exceptional cases, the tax administration cannot disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. The guidelines discourage restructuring of legitimate business transactions except where (i) the economic substance of a transaction differs from its form and (ii) the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. The OECD guidelines should be taken as a valid input in judging the action of the TPO because, in a differen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the assessee not only received the technology support as well as the related intangibles in terms of production processes, but has also benefitted from these technological practices, standards and know-how which were not created locally by itself. The Toyota Production System, standardized on a world-wide basis, has also been studied for its operational efficiency by premier academic institutions. I am inclined to agree with this conclusion after examining the facts of the appellant's case and the evidences available. The TPO's argument that no benefit was derived by the appellant from the technology for which royalty was paid is not supported by facts and evidences. The fact that the royalty rate was within the permissible limit specified by the Govt. of India and approved by the RBI is an additional argument in support of the legitimacy of the said payment. 10.4 In view of the above discussion, the TPO's determination of the ALP of the royalty payment at 'nil' cannot be supported. For such ALP determination, a proper analysis of comparables is required to be performed for FY 2004-05 and the TPO is directed to identify suitable comparables and, after pr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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