TMI Blog2012 (11) TMI 1X X X X Extracts X X X X X X X X Extracts X X X X ..... of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses." Earlier to this they have observed that Revenue cannot disallow any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was unremunerative. Looking into observations of their Lordships, it has to be held that reasonableness of an expenditure has not been excluded from determination. Decision in CIT v. EKL Appliances Ltd. [2012 (4) TMI 346 - DELHI HIGH COURT] relied upon - Decided partly in favor of assessee. - ITA No. 5141 (Delhi) of 2011 - - - Dated:- 11-5-2012 - G.D. Agrawal, And I.P. Bansal, JJ. For the Appellant: Rahul Mitra, Tarun Arora and Ms. Deepa Nanda For the Respondent: Gyan P. Srivastava and Peeyush Jain ORDER I.P. Bansal, Judicial Member - This is an appeal filed by the assessee and it is directed against the assessment order passed on 29th September, 2011 u/s 143(3) of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nes); 1.3.4 not appreciating that the Appellant had received economic and commercial benefit from the said international transaction of receipt of second line support and determining the Arm's Length Price for receipt of such services as nil based on erroneous assumptions that these services were in the nature of shareholder services; 1.3.5 no giving cognizance to the detailed analysis, arguments, explanations, evidences, etc. submitted by the Appellant, in support of the arm's length nature of its related party transaction of receipt of second line support, thereby violating the principles of natural justice; 1.3.6 adopting a contrary view to the stand taken by the department in the previous assessment years; 1.3.7 by disregarding established judicial pronouncements in India in making the Transfer Pricing adjustment; 1.4 The learned Assessing Officer erred by proposing to compute interest u/s 234B and 234D of the Act mechanically and without recording any satisfactory reasons for the same," 2. e-return declaring total income of Rs.184,49,21,960/- was filed on 31st October, 2007, Simultaneously book profits were declared u/s 115JB at Rs. 141,10,26,898/-. Subsequent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee at Rs. 184,49,21,960/-During the year the assessee entered into various international transactions with its Associate Enterprises (AE) which are listed below: Nature of Transaction Method selected Total value of transaction (Rs.) Purchase of Asset TNMM 53,485,934 Purchase of Finished Goods 4,477,671,804 Purchase of raw materials, spare etc. 7,907,880,312 Receipt of Services 1,484,502,908 Rendering of services 394,977,949 Contract cost credit 1,352,108,534 Cost Recharges 2,918,485 Software License fee 917,726,905 Rendering of services (software development services) 297,278,912 Cost Recharges CUP 350,182,321 4. It was further noticed by TPO that assessee has made following payments to its AE as under: S. No. Particulars Amount in INR 1. Consultancy 211,666,073 2. Administrative fee and reimbursement of expat salary 168,313,194 3. IS/IT Cost 550,640,396 4. R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ient of intra group services? 3. In order to identify the charges relating to services, there should be a mechanism in place which can identity (i) the cost incurred by the AE in providing the intra group services and (ii) the basis of allocation of cost to various AEs." 8. Ultimately the learned TPO has determined Arm's Length price at nil of the Second Line Support payments made by the assessee to its AEs and suggested a TP addition of Rs. 31,34,48,369/- and he has summarized his conclusion as under: "It may be mentioned here that the assessee has not been able to prove that this service has benefited in any way. The services that may have benefited the assessee have not been interfered with. As per the discussion above, if the assessee is unable to show that a tangible benefit has accrued to it, or that the services are in the nature of stewardship/shareholder services, or that an independent enterprise would not have paid for the services they are not considered to be at Arm's Length. Based on the discussion in the preceding para it can be concluded that the assessee has not been able to demonstrate that it has acted as an independent entity would have. Accordingly, b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not function as per specification. Consultation services: Answers/recommendations relating to general system operation and maintenance queries of the customer. Repair Service: The assessee extends services to customers for repair of faulty hardware that does not function in accordance with prescribed specifications. The assessee, however, sends the faulty hardware to the AEs for repairs. 11. Referring to the aforementioned factors of the service, it is the case of the assessee that these services are extremely critical for the customers of the assessee, as faults in the system (especially of emergency nature) can prove to be very costly for the telecom service provider/customer. All routine maintenance and repair services are undertaken by the assessee using its own personnel. However, to take care of complicated technical problems, the assessee utilizes the services of the AEs. In case of high-end technical support relating to repair of hardware/software, the assessee obtains the same from the AEs/manufacturer of the equipment and assessee has round the clock access to help desk services from its AEs. 12. It is also the submission of the assessee that Ericsson ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the systems (especially of emergency nature) can prove to be very costly for the telecom service provider/customer. All routine maintenance and repair services are undertaken by the assessee using its own personnel However, to take care of complicated technical problems, the assessee utilizes the services of the AEs. The assessee also operates 24 7 customer helpline on which customer can log on their complaints in case a fault is detected in the network. As soon as the complaint is logged by the customer, a Customer Service Request is generated. He referred to the copies of CSR placed at pages 187 to 207 and 277 to 336 of the paper book, The CSR is forwarded to first level support (FLS) technical team of the assessee and it is identified by the technical team that whether the problem relates to hardware or software. If it is due to software then FLS analyses the problem and tries to rectify the same on its own and in case it is unable to resolve the said error, then the problem is escalated to Second Level Support (SLS) team and solution is provided by the SLS and upon providing the solution, the CSR is closed. 15. Learned AR submitted that during the year under consideration th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thod instead of Transactional Net Margin Method (TNMM) applied by the Appellant. 6. The Hon'ble DRP/learned TPO further ignored the detailed analysis, explanations, evidences, etc. submitted in support of the arm's length nature of its related party transaction of receipt of second line support services. 7. The learned TPO while disallowing the payment for second line support services also ignored that the Appellant had received similar services from the AEs in the previous years also and the same had been held to be at arm's length, 8. The Hon'ble DRP although accepted the fact the business model of the Appellant had not undergone a change however still went ahead to uphold the adjustment made by the learned TPO." 16. He submitted that arguments of the assessee against these allegations are as under: "1. As mentioned above, the Appellant undertakes manufacturing and distribution of telecommunication carrier equipment for sale to independent customers, marketing of telecom equipment manufactured by Group Companies and implementation, commissioning, and support services related to telecommunication systems. Since each of these activities is closely interlinked with t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies providing support services as is evident from the fact that the comparable companies engaged in providing system support services earn OP/Sales of 4.74%. Accordingly, the Appellant's international transaction of second line system support services is at arm's length. 7. the learned TPO however rejected the above approach by merely stating that the above segment did not form part of the segmental accounts of the Appellant. While doing so the learned TPO ignored the fact that it was he himself who had rejected the primary approach of the Appellant for determination of arm's length margin. Now when the Appellant has tried to justify the arm's length margin through an alternative approach the learned TPO is unwilling to accept the same. 8. Learned TPO also did not take cognizance of evidences provided in support of the arguments that these services were actually received from the AEs. Further, the learned TPO also ignored the submission made by the Appellant to show that these services were highly technical and were actually required by the Appellant. 9. In the impugned Transfer Pricing Order the learned TPO has alleged that the Appellant should not have made any paymen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here that earlier the hearing took place on 09/04/2012 when learned AR had advanced aforementioned arguments. It was found that the agreement of the assessee with its AE for Second Line Support arrangement was not placed in the paper book. Therefore, the learned AR sought time and the matter was adjourned to 12/04/2012 when the hearing was concluded. On 12/04/2012 learned AR submitted that Department cannot question the Appellant's business/commercial expediency for availing the services from its AEs. He submitted that it is the prerogative of the Appellant to undertake the business/commercial decisions while determining whether it requires a particular service and if so, from where to avail such service. He submitted that recently Hon'ble Delhi High Court vide its judgment dated 10th April, 2002 in the case of CIT v. EKL Appliances Ltd. [I.T (Appeal No.1068 of 2011) has set out this principle wherein their Lordships have observed that quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereon the ground that the assessee has suffered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AEs from whom it had purchased telecom equipments to be supplied to the Aircell Cellular Ltd. (third party customer) and had drawn our attention to clause 18.2 and 18.3 of the said agreement which relates almost provisions with regard to hardware spare parts, tools and test equipments in which it has been mentioned that the supplier shall, for a period of 12 months from the respective date of acceptance by Aircell, at its option repair/replace, without expenses to the buyer, any part of the hardware found not be in conformity with the specifications by reason of defective material, design or workmanship, provided that the buyer notifies the supplier of such non-conformities without undue delay from becoming aware of them. Similar provision is contained under clause 18.3 regarding software. He submitted that above clause of the two agreements will clearly demonstrate that the assessee has extended the same warranty conditions to Aircell Cellular Limited as has been extended to it by its AE on a back to back basis. He submitted that post the expiry of such warranty period an AMC was entered for which a separate payment was made by Aircell Cellular Limited. For rendering these AMC se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee is responsible for the failure that may occur in the process of commissioning and installation of equipment. In that event there is no reason why the assessee should make the payment for routine service that the AE may provide. He submitted that it has been described by the TPO that the helpline exists for the entire group and not for the assessee alone and, therefore, this service is in the nature of stewardship service which AE is providing to the subsidiaries. He submitted that the rule 10B describes the determination of arm's length price u/s 92C according to which one of the appropriate method has to be adopted for which in the case of the assessee the appropriate method is comparable uncontrolled price method (CUP). It was submitted that the assessee has not submitted any justification for making such a huge payment to its AE which was not at all required to be made. Referring to the formula, according to which the payment has been made, he submitted that this is self-serving formula as it is related to gross revenue, which cannot be a criteria and formula itself suggests that in any case the assessee has to make payment to the AEs @60%. He submitted that tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... diture could not have been gone into by the Assessing Officer. It was observed that the purpose for which such permission is given by the Reserve Bank of India is totally different The Reserve Bank of India is only concerned with the foreign exchange and, therefore, would look into the matter from that point of view. The Reserve Bank of India, at the time of giving such permission would not keep in mind the provisions of the I.T. Act and that is the function of the income-tax authorities and, therefore, they can validly go into such an issue and in this manner the question was answered in the favour of the Revenue. Referring to these observations the learned D.R. pleaded that when examining the question of allowability of expenditure the same has to be viewed from the viewpoint of provisions of I.T. Act and, therefore, he pleaded that the Assessing Officer is authorized by the Act to go into the question of allowability or otherwise of the expenditure. 26. In the rejoinder, it was submitted by learned AR that actual cost is worked out and a formula has been adopted for meeting the obligations of the assessee under AMC agreements. He referred to the copy of consultation service co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Private Limited: Financial Year 2006-2006: Assessment Year 2007-08 Allocation Formula No of customer service Requests escalated by Service recipient 60% + No. of installed nodes 40% Cost of providing services Global no. of CSR's No. of global installed nodes Number of customer service requests escalated from India 1,245 Number of Global customer Service Requests (Appx.) 22,986 No of installed nodes in India 851 Number of global nodes (Appx) 16,093 Cost of providing services (in Eurp) (Appx) 104,154,447 Application of Formula on actual numbers 1245 60% + 851 40% 104,154,447=5,588,576 22986 16093 Second line support allocation for FY 06-07 (in EURO) 5,558,576 Second Line Support allocation for FY 06-07 (INR in crore) 31.44 (Converted at an average EURO INR Exchange rate of Appx.Rs.56 per Euro) Supporting working has been given as follows: I. Supporting workings Working parameters ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee. It has been submitted that during the relevant assessment year the assessee has received customer service request to the tune of 11,108 out of which 1,245 have been addressed for SLS. No doubt that equipment has been supplied by the parent company of the assessee and the parent company of the assessee, who has supplied the instruments, can only resolve the complicated problems. During the warranty period, it is the liability of the parent company to resolve the problem without any charge. Therefore, reference to the warranty period is not relevant in the present case more particularly as AMC itself stands on different footings for which separate revenue has been received by the assessee. Supply of equipments is one thing and service of the equipments after the warranty period is another thing. In commercial words it is well known that after the expiry of warranty period the AMC is obtained for the faultless working of the equipment. The assessee is receiving separate consideration on account of AMC after the expiry of the warranty period and the figures relating to that have already been mentioned. The gross revenue has been earned at Rs. 118,94,04,863/-. To ensure th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee in his business, he could have fared better had he not incurred such expenditure. Whether or not to enter into the transaction is for the assessee to decide. It will be relevant to reproduce these observations of their Lordships which is contained in para 22 of the order as under: "22. Even Rule 10B(1)(a) does not authorize disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in view of the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no aut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case of the learned AR that this formula is more logical and reasonable but at the same time this formula has not been examined by the authorities below. Though on the face of it the arguments of learned AR appear to have force but unless the new formula is also confronted to the Assessing Officer, it will be wholly unjustified to uphold the correctness reasonableness of this formula which has been placed before us for the first time. Therefore, we consider it just and proper to restore the issue regarding determination of arm's length price with regard to the impugned transaction to the file of the Assessing Officer redetermine the same in the light of the aforementioned observations. Needless to observe that assessee should be given reasonable and sufficient opportunity of hearing for presenting its case. 31. With these observations, grounds relating to addition of Rs. 31,34,48,369/-are disposed of and are considered to be partly allowed for statistical purposes. 32. So far as it relates to computation of interest u/s 234B and 234D, as no arguments were advanced by both the parties, we hold that the levy of the same is mandatory. However, the Assessing Officer is directed t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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