2018 (1) TMI 1366 - AT - Income Tax

TPA - computing the arm s length price in respect of international transaction - Working capital adjustment - Held that - The facts of the case are identical to the facts of Assessment Year 2006-07. Since DRP has not given the benefit of working capital adjustment while computing the arm s length price in respect of international transaction we set aside the matter to the file of the Assessing Officer with the direction to examine the case of the assessee and decide the issue afresh in accordance with the provisions of law. The A.O. will provide necessary opportunity to the assessee of being heard. Risk adjustment - Held that - There is no dispute regarding the risk factors that should be taken into account by granting certain adjustments to the main margin of comparables. TPO has observed that assessee is a contract research service provider to its parent group and are not dependent on market situations. It is also been observed by TPO that assessee is assured of a fixed return on cost and therefore they are risk insulated entity whereas the comparables chosen are independent companies and there s full risk associated with the normal enterprise real venture. As robust data was not available before Ld. TPO he did not grant any adjustment in regard to the risk undertaken by the comparables vis-a-vis no risk undertaken by assessee - this issue regarding granting of working capital and risk adjustment back to the file of Ld. TPO for re- computation on the basis of data made available to him. Disallowance of warranty expenses claimed - Held that - As decided in assessee s own case in the preceding assessment years we allow the claim of provision for warranty as business expenditure. Accordingly this ground raised by assessee stand allowed. Disallowance on marketing expenses incurred by assessee on account of providing handsets to its dealers and employees treating the same as capital asset - Held that - Undisputedly assessee is a company which is engaged in import and sale of mobile handsets. It has a wide team of dealers and sales personnel. Assessee has given free of cost Mobile to all these persons for communication amongst themselves for the business of assessee. Assessee has therefore debited the cost of these phones as marketing expenses and reduced it from its inventory - naturally the expenditure of giving phones to sales team is an expenditure incurred by assessee wholly and exclusively for the purpose of business of assessee. Assessee has also not capitalized these phones for the obvious reasons that phones are not owned by assessee and therefore there is no requirement of claim of depreciation thereon. Thus expenditure is revenue in nature assessee is eligible for deduction under section 37 (1) - decided in favour of assessee Enhancement of value of closing stock - handsets damaged during the transit and those provided to assessee s employees and dealers etc are to be treated as capital assets - Held that -In the foregoing paragraphs in respect of ground numbers 5 and 5.1 the cost of handsets given away to employees and sales team have been treated to be revenue in nature. Further admittedly assessee has not capitalised such handsets given away to the sales team and employees by reducing it from the inventory stock. As these handsets are held to be not owned by assessee value of such handsets cannot be added back to the closing stock. This would amount to double edition. Accordingly this ground raised by assessee stands allowed. Disallowance of 25% of provision for stock obsolescence by treating the same as unexplained - Held that - Assessee has created the provision for obsolescence with the view that in the event for any reason these handsets/accessories become saleable it would anyways form part of profits. We therefore set aside this issue to Ld. AO for valuing such obsolete stock at net realisable value. He should give due consideration to the information if any provided by the assessee.

Summary

Issues Involved:
1. Validity of reference under section 92CA(1) of the Income-tax Act.
2. Transfer pricing adjustments.
3. Disallowance of provision for warranty.
4. Disallowance of marketing expenses.
5. Enhancement of value of closing stock.
6. Disallowance of provision for obsolescence of inventory.

Detailed Analysis:

1. Validity of Reference under Section 92CA(1):
The appellant challenged the validity of the reference made by the Additional Commissioner of Income-tax to the Transfer Pricing Officer (TPO) under section 92CA(1) of the Income-tax Act, arguing that the Additional Commissioner had not recorded any reasons for the reference. The Tribunal did not specifically address this issue, as it was not pressed by the appellant during the hearing.

2. Transfer Pricing Adjustments:
The appellant contested the adjustments made to its income by the TPO, which were partially upheld by the Commissioner of Income Tax (Appeals) [CIT(A)]. The Tribunal addressed several sub-issues:

- Working Capital Adjustment: The appellant claimed a working capital adjustment based on its transfer pricing study. The Tribunal noted that the issue had been settled in favor of the appellant in previous years and directed the TPO to follow a scientific basis for computing the working capital adjustment.

- Risk Adjustment: The appellant argued for a risk adjustment due to its status as a risk-insulated entity. The Tribunal observed that the TPO had recognized the need for a risk adjustment but did not grant it due to a lack of robust data. The Tribunal remanded the issue back to the TPO for re-computation based on available data.

3. Disallowance of Provision for Warranty:
The appellant claimed a deduction for warranty expenses, which was disallowed by the AO and upheld by the CIT(A) on the grounds that it was a contingent liability. The Tribunal referred to previous decisions in the appellant's own case, where the provision for warranty was allowed based on past experience and scientific basis. The Tribunal followed the principle of consistency and allowed the provision for warranty as a business expenditure.

4. Disallowance of Marketing Expenses:
The appellant incurred expenses on providing handsets to dealers and employees, which were treated as capital assets by the AO. The Tribunal noted that the handsets were given for business purposes and were not owned by the appellant. Therefore, the expenses were considered revenue in nature and allowed as a deduction under section 37(1).

5. Enhancement of Value of Closing Stock:
The AO enhanced the value of the appellant's closing stock by treating handsets given to employees and dealers as capital assets. The Tribunal held that since the handsets were not owned by the appellant and were treated as revenue expenses, their value could not be added back to the closing stock. This ground was allowed in favor of the appellant.

6. Disallowance of Provision for Obsolescence of Inventory:
The appellant made a provision for obsolete inventory, which was partially disallowed by the AO and upheld by the CIT(A). The Tribunal noted that the provision was made following the appellant's global policy for obsolescence and was consistent with accounting standards. The Tribunal remanded the issue back to the AO to value the obsolete stock at net realizable value, considering the information provided by the appellant.

Conclusion:
The appeal was partly allowed, with several issues remanded back to the TPO or AO for re-evaluation based on the Tribunal's directions. The Tribunal emphasized consistency with previous decisions and adherence to scientific and accounting standards in its judgment.