TMI Blog2013 (5) TMI 852X X X X Extracts X X X X X X X X Extracts X X X X ..... n the earlier years, upto Assessment Year 2005-06.- Decided in favour of assessee Disallowance of provisions for leave encashment u/s 43B - Held that:- As to whether there has indeed been a double addition, needs to be verified by the Assessing Officer by confirming as to whether or not the assessee had made the disallowance itself and the amount had not been carried to the Profit & Loss Account. For this purpose, the matter is remitted to the file of the Assessing Officer, to be decided afresh in accordance with the law, on affording adequate and due opportunity to the assessee Disallowance u/s 14A of the Act read with Rule 8D - assessee has contended before us that the assessee had itself worked out a disallowance of ₹ 12,61,008/-; that however, neither the Assessing Officer, nor the DRP adjudicated on the aspect as to how such disallowance made by the assessee itself was incorrect or not acceptable - Held that:- The matter needs verification by the Assessing Officer, for which purpose, it is remitted to the file of the Assessing Officer. The Assessing Officer shall re-adjudicate the matter in accordance with law on affording adequate opportunity to the assessee, part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ircumstances of the case in erroneously exceeding their jurisdiction by judging the royalty payments made by the assessee through a benefit test, which is not based on not any of the method prescribed as per Section 92C of the IT Act. 5. The DRP as well as the A.O. has erred in law and facts and circumstances of case and made additions amounting to ₹ 84,48,000/- on account of disallowance of provisions for warranty u/s 37(1) of the IT Act. 6. The DRP as well as A.O. has erred in law and facts and circumstances of the case and made additions amounting to ₹ 1,75,26,309/- on account of disallowance of provisions for leave encashment u/s 43B of the IT Act. 7. The DRP and consequently A.O. has erred in law and facts and circumstances of the case and made additions amounting to ₹ 11,26,737/- on account of disallowance u/s 14A of the IT Act r.w. Rule 8D of I Tax Rules. 8. That the adjustment made by the A.O. of ₹ 50,105/- to the total income of the assessee on the ground of disallowance of depreciation on computer s peripherals @ 60% were erroneous, factually incorrect, and not maintainable in law and is prayed not to be confirmed. 9. The DRP and con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n AE of the appellant. Similarly, the other 100% subsidiaries of Stanley Japan also became AE s of the appellant as per the definition of associate enterprise as contained in Section 92A (2) read with its various clauses. 3. Ground Nos.1 and 2 are general. 4. Apropos Ground No.3, the facts are that the assessee company filed its return for the year under consideration, declaring income of ` 17,81,88,750/-. This return was processed u/s 143 (1), on 12.09.2009. A draft assessment order u/s 144C of the IT Act was served on the assessee. The assessee filed its objections before the DRP on 26.12.2011. The said objections were disposed of by the DRP vide Order dated 14.06.2012. The final assessment order was passed on 17.07.2012. The present appeal has been preferred thereagainst. 5. The TPO, vide Order dated 30.10.2011, passed u/s 92CA (3) of the Act, suggested upward assessment of assessee s income by `5,32,07,016/-, observing as follows:- In the present case the taxpayer has benchmarked the transaction related to payment of royalty under CUP. Hence, the CUP taken by the taxpayer is not acceptable for the reasons discussed above. But as discussed in the preceding paras ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... independent person in such a situation will pay any royalty. This view is also supported by the ITAT, Delhi s decision in the case of Abhishek Auto (2010-TII-54-ITAT-DEL-TP) wherein the ITAT held as under:- If the tested party without the use of imported technology and imported raw material can make additional margins, then it would be case the international transactions have demonstratively boosted the profits of the appellant. In view of the above discussion and particularly keeping in view of the fact that the assessee has neither benchmarked this transaction property by applying the most appropriate method and nor has it furnished the requisite information I am constrained to determine the arm s length price of this transaction at NIL under CUP method. No independent person in similar circumstances would pay any such royalty. I am aware of the ITAT, Delhi s decision in the case of Ekla Appliances (2011-TII-37-ITAT-DEL-TP). However, the aforesaid decision is not applicable as in that case it was found that the technology had helped the taxpayer in reducing its losses significantly. It was also found that there were peculiar reasons for incurring the losses. Thus, the af ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d economic benefit from the know-how received by it from its AE; that it has not been appreciated that the royalty was one of the two elements of cost and sales and could have been evaluated under the same overall method, as correctly done by the assessee under the TNMM; that it has not been appreciated that the royalty payment was not independent of sales and could not have been examined on a standalone basis; that it was not correct to judge the royalty payment on the yardstick of the benefit test, the same not being based on any of the methods prescribed u/s 92C of the IT Act; that it has wrongly not been taken into consideration that it was since 1984, that the assessee was in association with Stanley Electric, Japan; that the assessee s relationship with Stanley Electric, Japan turned into that of an AE in 1994; that it has not been appreciated that royalty payment was being made by the assessee to Stanley Electric, Japan, right from 1984 and this continued even after Stanley Electric, Japan acquired the status of an AE of the assessee; that it has not been appreciated that in 1984, the assessee was a small company, having a turnover of just about ` 2 crores, whereas in the ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der consideration in India, there would have been a loss; that this aspect of the matter has also not been taken into consideration; that further, it is wrong to state that no economic benefit accrued to the assessee vis-a-vis the payment of royalty, since the royalty was paid only in respect of the Japanese customer, i.e., on 43% sale; that as available from APB-I, page 385, i.e., the total of royalty paid by the assessee to its AE, for the period from 1.4.07 to 31.3.08, the royalty is about 2.43% of the net sales of ` 2180871964.63; and that the TPO did not deem it fit to do any benchmarking qua the issue of royalty, i.e., no comparable was brought. Besides the case laws mentioned hereinabove, the ld. counsel for the assessee has sought to place reliance on KHS Machinery (P) Ltd. vs. ITO , 53 SOT 100 (Ahm.), wherein, it has been, inter alia, held that where the Assessing Officer had not brought on record the ordinary profits which could be earned in the type of business carried on by the assessee, the finding of the Assessing Officer in considering royalty charges as nil as ALP, could not be accepted and that therefore, the payment of royalty was not hit by the provisions of Sec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s business is to be carried on, but he facts in the present case are in pari materia with Knorr Bremse (supra), wherein also, the assessee had incurred losses. 12. Addressing the issue as to whether nil ALP could have been allowable, the Ld. DR has submitted that there may be a benefit, but it cannot be a passive and incidental benefit it has to be a tangible benefit. Here, he places reliance on Knorr Bremse (supra) and Delloite (supra). 13. On the issue of consistency, the Ld. DR has contended that it is well settled that a mistake cannot be allowed to be perpetuated; that if in the earlier years, a claim had been mishappenly accepted, such a mistake cannot bind the Department forever; that moreover, in the earlier cases, the payment was considered u/s 37 of the Act and not u/s 92C thereof. Reliance has been sought to be placed on CBDT Circular No.12 of 23.08.2001 (copy placed on record). 14. The Ld. DR has further contended that even otherwise, the royalty should be separately benchmarked, as there is a chance of cross-subsidisation. He further contended that in the present case, there is no intangible involved and the assessee sells products under the brand name ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pproved by the Government since 1984. Ever since, the assessee had been carrying out the manufacture of some of its products under the brand name of Stanley. For this, the assessee had been paying royalty. Approval in this regard had been pre-obtained from SIA, as required. The RBI had also granted its approval, which was being renewed yearly. Initially, the royalty had been paid @ 4% on the sale of some of the products produced under the brand name Stanley. Later, it was reduced to 3%. In F.Y. 2003- 04, Stanley Electric Company of Japan acquired the status of the AE of the assessee. Thus, it was right from 1984, that technical assistance got started being given by Stanley Electric Company, Japan to the assessee, with regard to the manufacture of automotive lighting equipment. As available from para 1.4 of the agreement in the year under consideration (copy at APB-I, 340-359, relevant portion at page 342), a non-exclusive licence had been granted by Stanley, Japan to the assessee, only for India. As per the conditions thereof, the assessee was to pay royalty on its net sales, after deduction from the net sale price of the licensed products sold by Lumax in India. The basis of c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a mention about RBI. So far as regards the DR s objection that the plea of earlier payment to the same party, when it was not the assessee s AE, has not been allowed, is not maintainable, it is to be reiterated here, as above, that the assessee did benchmark its transaction by two methods, i.e., CUP and TNMM and this was taken note of by the TPO himself. Apropos the reliance by the Department on CGM Global (supra), it is correct that therein, the internal CUP was held to be not applicable, since the transaction was with an AE having related party transactions and it was held that there was no external CUP for making any comparison in the relevant year, as the earlier Agency Agreement with the third party had expired and rates applicable in the earlier years could not be made applicable during the relevant year. However, this decision does not have any adverse effect on the case of the assessee. The facts herein are entirely at variance with those of CGM Global . Herein, as opposed to the facts in CGM Global , the same Royalty Agreement and the same licence has been in continuance from 1984 till the year under consideration, the licence being renewed from year to year, albeit on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ral propositions of law relevant to the specific facts present in those cases. In the present case, an ALP analysis had been done by the assessee, as above. The assessee applied the CUP method and the TNMM. The TPO, however, despite being legally bound to do so, did not apply any method. 32. Apropos the decision of the Delhi Bench of the Tribunal in the case of Interra Information Technology (I) Pvt. Ltd. vs. DCIT , 2012- TIOL-142-ITAT-DEL-TP (supra), it is seen that here also, the facts are at a complete variance with those of the assessee s case, wherein payment of royalty for supply of technology and knowhow to manufacture licensed products was held to be for the benefit of the assessee and the same rate of royalty payment was allowed as allowed in the years when the parties were not in an AE relationship, but were having identical transactions as those in the year under consideration before the Tribunal. It was held that the royalty payment was a revenue expenditure incurred wholly and exclusively for the benefit of the assessee. The part of the payment disallowed as capital expenditure was held by the Hon ble Delhi High Court to be revenue expenditure. It is as such that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ier years, where the arguments were at an exactly similar, nay identical footing. 33. The TPO has made the disallowance in question mainly on the basis of the benefit test. In this regard, it is seen that the payment of royalty cannot be examined divorced from the production and sales. Royalty is inextricably linked with these activities. In the absence of production and sale of products, there would be no question arising regarding payment of any royalty. Rule 10A(d) of the ITAT Rules defines transaction as a number of closely linked transactions. Royalty, then, is a transaction closely linked with production and sales. It cannot be segregated from these activities of an enterprise, being embedded therein. That being so, royalty cannot be considered and examined in isolation on a standalone basis. Royalty is to be calculated on a specified agreed basis, on determining the net sales which, in the present case, are required to be determined after excluding the amounts of standard bought out components, etc., since such net sales do not stand recorded by the assessee in its books of account. Therefore, it is our considered opinion that the assessee was correct in employing an ov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is deleted as such. Accordingly, ground Nos.3 and 4 raised by the assessee are accepted. 37. Coming to ground No.5, the assessee contends that addition of ` 84,48,000/- on account of disallowance of provisions of warranty u/s 37(1) of the Act has wrongly been made and confirmed. The Assessing Officer noted from Form No.3CD that the assessee had made provision for warranty. The assessee was asked to show cause as to why the same be not disallowed, as it was a contingent liability. The assessee submitted that during the year, it had worked out the amount of net warranty liability by applying a multiplying factor on the total sales made during the year on the basis of past results and had made provisions in its books; that since the provision had been made based on the past factor of actual expenses incurred towards warranty liability, deduction claimed with regard thereto u/s 37(1) of the Act was an allowable expenditure. Reliance was placed on the Tribunal decision in the case of DCIT, Circle 4 (1) vs. LG Electronics (I) Ltd. and the Hon ble Supreme Court decision in the case of Rotork Controls India Pvt. Ltd. vs. CIT , 314 ITR 62 (SC), beside other case laws. The Assessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the actual warranty expenses during the immediately prior period, on the sales made. It has not been shown as to how this basis of making provision for warranty is not scientific. Moreover, similar provision for warranty was not disallowed in the earlier years, upto Assessment Year 2005-06. This position is also supported by the Hon ble Supreme Court s decision in Rotork Controls India Pvt. Ltd. (supra) and the Hon ble Delhi High Court decision in Becton Dickinson (supra). Accordingly, this addition is deleted and ground No.5 is allowed. 41. Apropos ground No.6, the assessee has challenged the addition of ` 1,75,26,309/- made on account of disallowance of provisions for leave encashment u/s 43B of the Act. 42. The Assessing Officer observed that the assessee s provisions for leave encashment had increased to ` 3,27,47,739/-. The assessee had maintained that the deduction had been claimed in view of the decision of the Hon ble Calcutta High Court in the case of Exide Industries vs. UOI , 292 ITR 470 (Cal). The Assessing Officer asked the assessee to show cause as to why the amount be not disallowed and added back to the assessee s total income, since the decision in Exid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lar income or receipt; and that by maintaining such investments and other investment related activities, administrative expenses were attributable to them. Accordingly, the Assessing Officer made the following disallowance u/s 14A of the Act read with Rule 8D of the IT Rules:- S.No. Disallowance Amount (Rs.) 1. The amount of expenditure directly relating to income which does not form part of total income 0 2. In a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula AXB/C Where A = amount of expenditure by way of interest other than the amount of interest included in clause (1) incurred during the previous year. B = the average of value of investment, income from which does not or shall not form part of the total income appearing in the balance sheet of the assessee, on the last day and the last day of the previous year. C = the average value of total assets as appearing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year % of average investment of ₹ 25,22,01,525/- = 12,61,008/- Total disallowance Less disallowance made by the assessee in computation of income Balance net disallowance Rs.48,62,647/- Rs.12,61,008/- Rs.11,26,737/- 49. As such, the disallowance u/s 14A of the Act read with Rule 8D of the Rules came to ` 11,26,737/-, which amount was added back to the total income of the assessee company. 50. The ld. counsel for the assessee has contended before us that the assessee had itself worked out a disallowance of ` 12,61,008/-; that however, neither the Assessing Officer, nor the DRP adjudicated on the aspect as to how such disallowance made by the assessee itself was incorrect or not acceptable; that the assessee is a manufacturing concern and its entire infrastructure is meant for manufacturing activities; that the assessee company has a turnover of about ` 508 crores from its manufacturing operations; that the Assessing Officer attributed interest ..... X X X X Extracts X X X X X X X X Extracts X X X X
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