Lenovo (India) Private Limited, Bangalore V. ACIT, Bangalore

ITA 1457/BANG/2010

• Counselvise Citation: [2012] 140 COUNSELVISE.COM (IT) 57522 (ITAT-BANGALORE)
• Duration Of Justice: 1 year(s) 3 month(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 16-03-2012
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: A
• Next Hearing Date: 08-02-2012
• Assessment Year: 2006-2007
• Appeal Filed On: 16-12-2010
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: ETWA MUNDA CITIII
• Assessee Lawyers: SRIRAM SESADRI
• Keywords: Capital asset; Transfer pricing; Business expenditure; Principle of natural justice; International transaction; Commercial expediency; Revenue expenditure; Capital expenditure
• Section: 43B; 143(3); 234B; 37

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL, BANGALORE BENCH A BEFORE SHRI N BARATHVAJA SANKAR, VICE RESIDENT AND SMT. P MADHAVI DEVI, JUDICIAL MEMBER ITA NO.1457/BAN G/2010 (ASST. YEAR - 2006-07) M/S LENOVO (INDIA) PVT. LTD., FERNS ICON LEVEL 2, DODDENAKUNDI VILLAGE, MARATHAHALLI OUTER RING ROAD, MARATHAHALLI, BANGALORE-560 037. . APPELLANT PAN NO.AABC13372H VS. THE ASST. COMMISSIONER OF INCOME-TAX, CIRCLE-11(5), BANGALORE. . RESPONDENT APPELLANT BY : SHRI SRIRAM SESADRI, CA RESPONDENT BY : SHRI ETWA MUNDA, CIT-III DATE OF HEARING : 08-02-2012 DATE OF PRONOUNCEMENT : -02-2012 O R D E R PER P MADHAVI DEVI, JUDICIAL MEMBER : THIS APPEAL IS FILED BY THE ASSESSEE. THE APPEAL IS DIRECTED AGAINST THE ORDER OF THE JT. COMMISSIONER OF INCOME -TAX (TP) - II AT ITA NO.1457/B/10 2 BANGALORE DATED 8.10.2010. THE APPEAL ARISES OUT O F THE ASSESSMENT COMPLETED U/S 143(3) OF THE INCOME-TAX ACT, 1961 2. THE ASSESSEE HAS FILED THE FOLLOWING CONCISE GR OUNDS OF APPEAL : (1) THE ORDER PASSED BY THE DISPUTE RESOLUTION PANEL (DRP) U/S 143(3) READ WITH SEC. 144C OF THE INCOME-TAX ACT, 1961 (ACT) IS CONTRARY TO LAW, FACTS AND CIRCUMSTANCES TO THE PRESENT CASE AND IN ANY CASE, MADE IN VIOLATION OF PRINCIPLES OF EQUITY AND NATURAL JUSTICE AS THE ASSESSEE WAS NOT BEING GIVEN AN ADEQUATE OPPORTUNITY OF HEARD AND WITHOUT CONSIDERING THE SUBMISSIONS MADE BY THE APPELLANT. (2) THE DRP HAS ERRED BOTH IN LAW AND ON FACTS IN UPHOLDING THE ADJUSTMENT BASED ON THE ORDER PASSED U/S 92CA OF THE ACT PASSED BY THE LEARNED JCIT (TP-II) (TPO) AS THE SAID ORDER WAS PASSED WITHOUT JURISDICTION. (3) THE DRP HAS ERRED BOTH IN LAW AND ON FACTS IN ARBITRARILY UPHOLDING THE REJECTION OF RESALE PR ICE METHOD (RPM) ADOPTED BY THE APPELLANT AS THE MOST APPROPRIATE METHOD (MAM) FOR IMPORT OF PARTS FOR MANUFACTURING SEGMENT AND INSTEAD ADOPTING THE ITA NO.1457/B/10 3 TRANSACTION NET MARGIN METHOD (TNMM) BY CONSIDERING THE RESALE OF PARTS INITIALLY IMPORTED FOR THE MANUFACTURING ACTIVITY AS A SEPARATE TRADING ACTIVITY IN ITSELF. (4) THE DRP HAS ERRED BOTH IN LAW AND ON FACTS IN ARBITRARILY UPHOLDING THE ADJUSTMENT WITHOUT APPRECIATING THAT THE SALE BACK OF THE REDUNDANT STOCK OF PARTS WS CLOSELY LINKED TO THE MANUFACTURI NG OPERATIONS CARRIED OUT BY THE ASSESSEE INVOLVING IMPORT OF PARTS FROM THE ASSOCIATED ENTERPRISES RATHER THAN A REGULAR BUSINESS ACTIVITY. (5) THE DRP HAS ERRED BOTH IN LAW AND ON FACTS IN ARBITRARILY UPHOLDING THE TNMM TO BENCHMARK THE SOFTWARE LICENSE AND FAILED TO APPRECIATE THAT THE ASSESSEE HAS MERELY REIMBURSED THE COST OF THE SOFTWARE PROCURED BY THE AE FROM THIRD PARTIES AND PROVIDED TO THE ASSESSEE. (6) THE DRP HAS ERRED BOTH IN LAW AND ON FACTS IN ARBITRARILY UPHOLDING THE DATA SET OF COMPARABLE S FOR BENCHMARKING MANUFACTURING SEGMENT UNDER TNMM ON THE GROUND THAT THE DATA OF THE COMPARABLE SET IS NOT IN ACCORDANCE WITH RULE 10B(4) OF THE INCOME-TAX RULES, 1962. ITA NO.1457/B/10 4 (7) THE DRP HAS ERRED IN LAW AND ON FACTS IN ARBITRARILY REJECTING THE CLAIM OF RISK ADJUSTMENT AND ALSO THE STANDARD ADJUSTMENT OF 5 PERCENT FROM THE ARITHMETIC MEAN MARGIN COMPUTED FOR BENCHMARKING UNDER TNMM FOR MANUFACTURING SEGMENT. (8) THE DRP HAS ERRED IN DISALLOWING AN AMOUNT OF RS.272,796,488/- IN RESPECT OF WARRANTY WITHOUT APPRECIATING THAT THE SAID WARRANTY PROVISION HAS BEEN CREATED IN A SCIENTIFIC MANNER GIVING DUE REGARD TO THE NATURE OF ACTIVITY AND INDUSTRY REQUIREMENTS. (9) THE LEARNED DRP HAS ERRED IN DISALLOWING THE R&D CESS PAYABLE U/S 43B OF THE ACT. (10) THE DRP HAS ERRED IN LAW AND ON FACTS IN ARBITRARILY CONFIRMING THE DISALLOWANCE OF RS.271,418,028/- BEING MARKETING SUPPORT FEES PAID TO IBM AS CAPITAL EXPENDITURE ON THE GROUND THAT IF RESULT ENDURING BENEFIT OF CAPITAL NATURE IN THE HA NDS OF THE APPELLANT. (11) THE DRP HAS ERRED IN LAW AND ON FACTS IN ARBITRARILY DISALLOWING FUTURE BILLING ADJUSTMENT (FBA) AND DUTY FREE REPLENISHMENT CERTIFICATE (DFRC) RECEIVABLE WRITTEN OFF CHARGED TO PROFIT AND LOSS ACCOUNT AMOUNTING TO RS.21,91,78,000/- AND ITA NO.1457/B/10 5 RS.5,26,89,000/- RESPECTIVELY ON THE GROUND THAT SUCH EXPENDITURE WAS INCURRED BY IBM INDIA AND NOT BY THE APPELLANT. (12) THE DRP HAS ERRED IN LAW AND ON FACTS IN UPHOLDING THE LEVY OF INTEREST U/S 234B AND 234D OF THE ACT. 3. AT THE TIME OF HEARING, THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE ASSESSEE IS NOT INTERESTED TO PU RSUE GROUND OF APPEAL NO.2 AND 9. THEREFORE, THESE GROUNDS ARE R EJECTED AS NOT PRESSED. 4. COMING TO THE GROUND NOS. 3 TO 7 RELATING TO TH E TRANSFER PRICING ADJUSTMENT MADE BY THE TPO AND CONFIRMED BY THE DRP , 5. THE BRIEF FACTS OF THE CASE ARE THAT THE ASSESS EE IS ENGAGED IN THE BUSINESS OF MANUFACTURE, IMPORT, MARKETING, DISTRIB UTION AND EXPORT OF INFORMATION TECHNOLOGY SYSTEMS, SOFTWARE AND MAINTE NANCE SERVICES ETC. IT FILED ITS RETURN OF INCOME ON 29.11.2006 D ECLARING A LOSS OF RS.74,89,28,827/-. DURING THE ASSESSMENT PROCEEDIN GS U/S 143(3) OF THE INCOME-TAX ACT, THE ASSESSING OFFICER OBSERVED THAT THE ASSESSEE HAS ENTERED INTO VARIOUS INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATED ITA NO.1457/B/10 6 ENTERPRISES. IN VIEW OF THE SAME, HE MADE A REFERE NCE TO THE TPO U/S 92CA OF THE INCOME-TAX ACT FOR DETERMINATION OF THE ARMS LENGTH PRICE (ALP) WITH REGARD TO THE SAID INTERNATIONAL T RANSACTIONS. THE TPO, AFTER CONSIDERING THE ASSESSEES CONTENTIONS W ITH REGARD TO VARIOUS TRANSACTIONS, ACCEPTED THE ALP DETERMINED B Y THE ASSESSEE IN ITS 92CA REPORT AS FAR AS 8 TRANSACTIONS ARE CONCER NED, BUT MADE TP ADJUSTMENT WITH REGARD TO THE FOLLOWING TRANSACTION S :- 1) SALE OF IMPORTED PARTS OF RAW-MATERIAL 2) PURCHASE OF IMPORTED PARTS OF RAW MATERIAL 3) SOFTWARE LICENCE AND 4) ROYALTY PAID. 6. THE TPO REJECTED THE METHODS FOLLOWED BY THE A SSESSEE FOR ARRIVING AT THE ALP FOR ALL THE ABOVE TRANSACTIONS AND ADOPTED THE TNMM AS THE MOST APPROPRIATE METHOD FOR ARRIVING AT THE ALP OF ALL THE TRANSACTIONS. THEREAFTER, HE DETERMINED THE A LP AS PER THE TNMM METHOD AND THE TP ADJUSTMENT WAS REPORTED TO T HE ASSESSING AUTHORITY. THE ASSESSING AUTHORITY AFTER TAKING IN TO CONSIDERATION ALL THE TP ADJUSTMENTS MADE BY THE TPO, DRAFTED THE ASS ESSMENT ORDER AND FURNISHED THE SAME TO THE ASSESSEE. ITA NO.1457/B/10 7 7. AGGRIEVED BY THE SAID DRAFT ORDER, THE ASSESSEE APPROACHED THE DRP AND THE DRP AFTER HEARING THE ASSESSEE CONFIRME D THE ORDER OF THE ASSESSING AUTHORITY AND THE ASSESSING OFFICER H AS ACCORDINGLY PASSED THE ASSESSMENT ORDER MAKING THE TP ADJUSTMEN T. 8. AGGRIEVED, THE ASSESSEE IS IN APPEAL BEFORE US. 9. THE LEARNED COUNSEL FOR THE ASSESSEE SHRI SRIRA M SESADRI SUBMITTED THAT THE ASSESSEE HAS FOLLOWED VARIOUS ME THODS FOR COMPUTING THE ALP OF DIFFERENT TRANSACTIONS DEPENDI NG ON THE NATURE OF TRANSACTIONS AND THE COMPARABLES AVAILABLE SUCH AS FOR THE SALE OF PARTS IMPORTED FOR THE PURPOSE OF MANUFACTURE, THE ASSESSEE HAS ADOPTED THE RESALE PRICE METHOD, FOR PURCHASE OF IMPORTED PARTS OF RAW MATERIAL, IT HAS ADOPTED INTERNAL CUP METHOD, FOR SOFTWARE LICENCE IT HAS ADOPTED CUP METHOD AND FOR THE ROYA LTY PAID, THE ASSESSEE HAS ADOPTED EXTERNAL CUP METHOD. THE LEA RNED COUNSEL FOR THE ASSESSEE DREW OUR ATTENTION TO THE ORDER OF THE TPO TO DEMONSTRATE THAT THE TPO HAS NOT APPLIED HIS MIND TO THE FACTS OF THE CASE BEFORE HIM FOR REJECTING THE METHODS ADOPTED BY THE ASSESS EE FOR ARRIVING AT THE ALP OF THE VARIOUS TRANSACTIONS. HE HAS ALSO D RAWN OUR ATTENTION ITA NO.1457/B/10 8 TO VARIOUS JUDICIAL PRECEDENTS ON THE ISSUE TO DEMO NSTRATE THAT WHERE TPO HAS NOT BEEN ABLE TO FIND ANY FAULT WITH THE ME THOD ADOPTED BY THE ASSESSEE FOR THE SAID PURPOSE, THE TPO IS BOUND TO ACCEPT THE TP ANALYSIS CONDUCTED BY THE ASSESSEE AND CANNOT TAKE A DIFFERENT VIEW. FOR THIS PURPOSE HE PLACED RELIANCE UPON THE CIRCUL AR NO.14 OF 2001 ISSUED BY THE CBDT TO THE EFFECT THAT WHERE THERE W AS NO INFIRMITY IN THE TP STUDY CONDUCTED BY THE ASSESSEE, AND THE TPO HAD NO BASIS FOR DISREGARDING THE SAME FOR THE PURPOSE OF COMPUTING/ FRAMING THE ASSESSMENT AND MAKING THE TP ADJUSTMENT, THEN THE T P ANALYSIS MADE BY THE ASSESSEE HAS TO BE ACCEPTED. 10. THE LEARNED COUNSEL FOR THE ASSESSEE FURTHER S UBMITTED THAT FOR THE SUBSEQUENT ASSESSMENT YEARS, I.E FOR THE ASSESS MENT YEAR 2007-08, THE VERY SAME TPO HAD ACCEPTED THE METHODS ADOPTED BY THE ASSESSEE FOR ARRIVING AT THE ALP FOR SIMILAR TRANSACTIONS AN D THERE WAS NO TP ADJUSTMENT MADE. HE HAS FILED THE COPIES OF THE TP OS ORDERS U/S 92CA OF THE ACT FOR THE ASSESSMENT YEAR 2007-08 AND ALSO 2008-09 WHEREIN NO ADJUSTMENTS WERE MADE AND THE TP ANALYSI S MADE BY THE ASSESSEE HAS BEEN ACCEPTED. THE LEARNED COUNSEL FO R THE ASSESSEE HAS ALSO FILED BEFORE US, THE COPY OF TRANSFER PRICING REVIEW FILED BY THE ITA NO.1457/B/10 9 ASSESSEE FOR THE ASSESSMENT YEAR 2007-08 TO DEMONST RATE THAT THE VERY SAME ISSUES HAD ARISEN FOR THE SUBSEQUENT ASSESSMEN T YEAR ALSO. 11. THE LEARNED DR ON THE OTHER HAND STRONGLY SUPP ORTED THE ORDERS OF THE AUTHORITIES BELOW AND ALSO FILED HIS WRITTEN SUBMISSIONS IN SUPPORT OF HIS CONTENTIONS. 12. HAVING HEARD BOTH THE PARTIES AND HAVING CONSI DERED THE RIVAL CONTENTIONS AND THE MATERIAL ON RECORD, WE FIND THA T THE ASSESSEE HAS FOLLOWED THE INTERNAL CUP METHOD FOR ARRIVING AT A LP FOR THE IMPORT OF RAW MATERIAL, WHERE AS THE TPO, IN HIS ORDER, HA S MENTIONED THAT THE ASSESSEE HAS ADOPTED THE EXTERNAL CUP METHOD. SIMILARLY, FOR THE ROYALTY PAYMENT, THE ASSESSEE HAS ADOPTED THE EXTER NAL CUP METHOD AND IT WAS A SINGLE PAYMENT, WHEREAS THE TPO OBSERV ED AT PAGE 21 OF HIS ORDER THAT IT IS RECURRING PAYMENT. THERE WERE MANY FLAWS IN THE TPOS ORDER WHICH DEMONSTRATE THAT THE FACTS OF THE CASE HAVE NOT BEEN PROPERLY APPRECIATED BY THE TPO WHILE MAKING T HE TP STUDY ANALYSIS. ANOTHER FACT WORTH NOTING IS THAT THE SI MILAR TRANSACTION WITH THE ASSOCIATED ENTERPRISES FOR THE SUBSEQUENT YEARS HAVE BEEN CONSIDERED BY THE TPO AND HAVE BEEN ACCEPTED WITHO UT ANY ALP ADJUSTMENTS. THERE HAS TO BE A CONTINUITY AND UNI FORMITY IN THE APPROACH OF THE REVENUE TOWARDS AN ISSUE AND PARTIC ULARLY IN THE CASE ITA NO.1457/B/10 10 OF THE SAME ASSESSEE. IN THE CASE OF THE ASSESSEE BEFORE US, THE ADJUSTMENTS HAVE BEEN MADE ONLY FOR THE RELEVANT AS SESSMENT YEAR, WHEREAS SIMILAR TRANSACTIONS HAVE BEEN ACCEPTED TO BE AT ALP FOR THE SUBSEQUENT YEARS EVEN THOUGH THE SAME METHOD HAS BE EN FOLLOWED BY THE ASSESSEE. WHEN THE FACTS AND CIRCUMSTANCES ARE EXACTLY THE SAME, THE REVENUE CANNOT BE PERMITTED TO TAKE A DIFFERENT APPROACH IN TWO DIFFERENT ASSESSMENT YEARS. IN VIEW OF THE SAME, WE DEEM IT FIT AND PROPER TO REMIT THIS ISSUE OF TP STUDY TO THE F ILE OF THE ASSESSING AUTHORITY WITH A DIRECTION TO VERIFY AS TO WHETHER THE SIMILAR TRANSACTIONS OF THE ASSESSEE WITH ASSOCIATED ENTERP RISES HAVE BEEN ACCEPTED BY THE TPO FOR THE ASSESSMENT YEAR 2007-08 AND 2008-09 AND IF IT IS FOUND TO BE TRUE, THEN THE AO IS DIREC TED TO ADOPT THE TP ANALYSIS CONDUCTED BY THE ASSESSEE FOR THE RELEVANT ASSESSMENT YEAR ALSO TO BE AT ALP AND MAKE THE ASSESSMENT ACCORDING LY. THESE GROUNDS ARE ACCORDINGLY ALLOWED FOR STATISTICAL PUR POSES. 14. AS REGARDS GROUND NO.8, THE BRIEF FACTS OF THE CASE ARE THAT THE ASSESSEE HAD ACQUIRED THE PERSONAL COMPUTER AND LAP TOPS DIVISION OF IBM INDIA AND CONTINUED BUSINESS OF TRADING AND MA NUFACTURE OF PCS AND MCS. THE ASSESSEE HAS PROVIDED EITHER 1 Y EAR OR 3 YEARS WARRANTY ON SALE OF PCS AND LAPTOPS MADE TO ITS CU STOMERS IN INDIA ITA NO.1457/B/10 11 AND THE PRICES FOR WARRANTY SERVICES HAS BEEN LOADE D IN THE SALE PRICE OF PCS OR LAPTOPS ITSELF. THE ASSESSEE DEBITED TH E ACTUAL WARRANTY EXPENDITURE INCURRED DURING THE YEAR AND ALSO THE A DDITIONAL PROVISION MADE ON THE BASIS OF ASSESSMENT OF WARRANTY LIABILI TY ON SALES MADE FOR THE UNEXPIRED PERIOD TO THE PROFIT AND LOSS ACC OUNT AND CLAIMED IT AS DEDUCTION. THE ASSESSING OFFICER OBSERVED THAT THE PROVISION OF WARRANTY MADE IS BASED ON GLOBAL EXPERIENCE WHICH M IGHT NOT BE SUITABLE FOR INDIA AND THIS BEING THE FIRST YEAR OF BUSINESS FOR THE ASSESSEE IN INDIA, IT HAS NO PAST EXPERIENCE OR DAT A RELATING TO REPAIR OF THEIR WARRANTY CLIENTS FOR THE SALES MADE. HE ALSO OBSERVED THAT ASSESSEE HAS INCURRED ONLY 22% OF THE TOTAL AMOUNT DEBITED TO PROFIT AND LOSS ACCOUNT AS WARRANTY EXPENDITURE AND, THERE FORE, THE PROVISION CREATED IS NOT BASED ON ANY REAL LIABILITY, DATA OR STATISTICS BUT IS AN UNASCERTAINED LIABILITY. THE ASSESSING OFFICER, TH EREFORE, DISALLOWED THE SAME AND ADDED IT TO THE INCOME OF THE ASSESSE E. ON APPEAL, THE DRP CONFIRMED THE ORDER OF THE AO AND THE ASSESSEE IS IN SECOND APPEAL BEFORE US. 15. THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE ASSESSEE HAS SOLD PCS AND LAPTOPS TO ITS CUSTOMERS WITH A WA RRANTY PROVISION ITA NO.1457/B/10 12 AND AS PER THE MATCHING PRINCIPLE, THE ASSESSEE HAS TO MAKE PROVISION FOR SUCH PROBABLE EXPENDITURE PROPORTIONATE TO THE SALES MADE. 16. THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE ASSESSEE HAD ACQUIRED THE BUSINESS OF PCS AND LAPTOPS FROM I BM IN INDIA AND THEREFORE, IT HAS ADOPTED THE BASIS ON WHICH IBM WA S MAKING THE PROVISION FOR WARRANTY IN THE EARLIER YEARS. HE SU BMITTED THAT THE PROVISION IS BASED ON SCIENTIFIC METHOD AND NOT ON AD-HOC BASIS. HE SUBMITTED THAT THE ASSESSEE HAS PROVIDED THE WORKSH EET WHICH WOULD CLEARLY SHOW THAT THE ASSESSEE HAD SCIENTIFIC METHO D OF ESTIMATING THE LIABILITY BASED ON PAST DATA AND, THEREFORE, THE PR OVISION OF WARRANTY IS ALLOWABLE. IN SUPPORT OF ITS CONTENTION, HE PLACED RELIANCE UPON THE FOLLOWING DECISIONS : 1) ROTORK CONTROLS INDIA PVT. LTD VS. CIT, (2009) 314 ITR 62 (SC) 2) CIT VS. ERICSSION AND COMMUNICATION PVT. LTD. IN 318 ITR 340, (DEL) AND UN-REPORTED DECISION OF THE TRIBUNAL IN THE CASE OF 3) APPLE INDIA PVT. LTD. IN ITA NO.609/BANG/2010. ITA NO.1457/B/10 13 HE HAS ALSO FILED COPIES OF THE SAID ORDERS BEFORE US. 17. HE FURTHER STATED THAT THE ASSESSEE HAD USED THE PAST YEAR DATA OF IBM, WHICH WAS IN BUSINESS TILL THE ACQUISITION OF THE BUSINESS BY THE ASSESSEE AND THAT THE PROVISION MADE IN THE CUR RENT YEAR HAS BEEN DECREASING WHERE AS THE ACTUAL EXPENDITURE ON WARRA NTY HAS BEEN INCREASING IN THE SUBSEQUENT YEARS, WHICH WOULD SHO W THAT THE PROVISION MADE HAS BEEN EXPENDED ACTUALLY IN THE LA TER YEARS. HE SUBMITTED THAT SINCE THE ASSESSEE HAS MADE THE PROV ISION ON SCIENTIFIC BASIS, THE PROVISION OF WARRANTY MUST BE ALLOWED AS DEDUCTION IN THE LIGHT OF THE ABOVE CITED DECISIONS. 18. THE LEARNED DR HOWEVER SUPPORTED THE ORDERS OF THE AUTHORITIES BELOW AND SUBMITTED THAT ALTHOUGH IN PRINCIPLE, THE HONBLE SUPREME COURT IN THE CASE OF ROTORK CONTROLS INDIA PVT. LT D., (CITED SUPRA) HAS HELD THAT PROVISION FOR WARRANTY CAN BE MADE AND CL AIMED AGAINST THE INCOME FOR THE RELEVANT PREVIOUS YEAR SUBJECT TO TH E FULFILLMENT OF THE CONDITION MENTIONED THEREIN, THE ASSESSEE HAS NOT F URNISHED THE STATISTICAL INFORMATION WITH REGARD TO THE SALE OF DESK TOPS AND LAP TOPS, AS THE WARRANTY PROVISION IS LOADED ON THE SA LE PRICE OF THE ITA NO.1457/B/10 14 PRODUCTS ON THE BASIS OF THE WARRANTY PROVISIONS AN D, THEREFORE, ACCORDING TO HIM THE MATTER SHOULD BE REMANDED BACK TO THE AO FOR RECONSIDERATION OF THE ISSUE AFRESH. 19. HAVING HEARD BOTH THE PARTIES AND HAVING CONSID ERED THE RIVAL CONTENTIONS, WE FIND THAT THE HONBLE SUPREME COURT IN THE CASE OF ROTORK CONTROLS IND. PVT. LTD., (CITED SUPRA) HAS H ELD THAT WHEN A PRODUCT IS SOLD WITH A WARRANTY PROVISION, IT CANNO T BE HELD THAT THE ASSESSEE HAS NO OBLIGATION FOR THE SAID WARRANTY BU T FOR MAKING A PROVISION FOR THE SAID WARRANTY A RELIABLE ESTIMATE SHOULD BE MADE ON THE AMOUNT OF OBLIGATION AND A SCIENTIFIC METHOD SH OULD BE USED. IN THE SAID DECISION, IT WAS HELD THAT A PROVISION IS A LIABILITY WHICH CAN BE MEASURED ONLY BY USING SUBSTANTIAL DEGREE OF EST IMATION AND IT IS RECOGNIZED WHEN - A) AN ENTERPRISE HAS A PRESENT OBLIGATION AS A RESU LT OF A PAST EVENT; B) IT IS PROBABLE THAT AN OUT-FLOW OF RESOURCES WIL L BE REQUIRED TO SETTLE THE OBLIGATION; AND C) A RELIABLE ESTIMATE CAN BE MADE ON THE AMOUNT OF THE OBLIGATION. ITA NO.1457/B/10 15 20. IN THE CASE BEFORE US, THE ASSESSEE HAS ACQUIRE D THE BUSINESS OF DESK TOPS AND LAP TOPS FROM IBM IN THE FINANCIAL YE AR RELEVANT TO THE ASSESSMENT YEAR 2006-07. THIS BEING THE FIRST YEAR OF ITS BUSINESS IN PERSONAL COMPUTERS, IT HAS NO DATA RELATING TO THE PROBABLE EXPENDITURE IT WOULD HAVE TO MEET ON ACCOUNT OF WARRANTY PROVIS ION. IT IS ALSO NOT DISPUTED THAT IBM WAS CARRYING ON BUSINESS IN INDIA IN THE EARLIER ASSESSMENT YEARS AND IBM WAS MAKING THE PROVISION F OR WARRANTY ON THE BASIS OF ITS GLOBAL DATA. THEREFORE, IT CANNOT BE SAID THAT THE ASSESSEE CANNOT USE THE DATA USED BY IBM FOR THE PA ST YEAR FOR MAKING THE ESTIMATION. IF THE ASSESSEE HAS MADE THE PROVI SION ON A SCIENTIFIC BASIS, IT HAS TO BE ALLOWED AS DEDUCTION. HOWEVER, THIS FACT AS TO WHETHER THE ASSESSEE HAS MADE THE PROVISION IN A SC IENTIFIC METHOD HAS TO BE VERIFIED BY THE ASSESSING AUTHORITY. IN VIEW OF THE SAME, WE DEEM IT FIT AND PROPER TO REMAND THIS ISSUE TO THE ASSESSING AUTHORITY TO RECONSIDER THE ISSUE AFRESH IN THE LIGHT OF THE GUI DELINES ISSUED BY THE HONBLE SUPREME COURT IN THE CASE OF ROTRACK CONTRO LS INDIA PVT. LTD (CITED SUPRA) AND OTHER JUDICIAL PRECEDENTS. THIS GROUND IS ACCORDINGLY ALLOWED FOR STATISTICAL PURPOSES. ITA NO.1457/B/10 16 21. AS REGARDS GROUND NO.10, THE LEARNED COUNSEL FO R THE ASSESSEE SUBMITTED THAT AS PART OF THE PERSONAL COMPUTER BUS INESS ACQUIRED BY THE ASSESSEE FROM IBM, THE ASSESSEE HAD ENTERED INT O A MARKET SUPPORT AGREEMENT (MSA) WITH IBM WITH A VIEW TO RETAIN A MA RKET SHARE IN THE STIPULATED BUSINESS. HE SUBMITTED THAT THE ASS ESSEE WANTED TO TAKE SUPPORT FROM IBM AS IBM HAS WELL ESTABLISHED ENTERP RISE SALES FORCE AND ESTABLISHED GLOBAL SALES INFRASTRUCTURE, SUCH A S CLIENT REPRESENTATION CENTRE ETC. FOR MORE THAN 52 YEARS AND FOR THIS SERVICE, THE ASSESSEE IS REQUIRED TO PAY IBM A PERCENTAGE OF ITS REVENUE. HE SUBMITTED THAT FOR THE YEAR UNDER REVIEW, THE ASSES SEE HAS PAID A SUM OF RS.27,14,18,028/- AS MARKET SUPPORT AGREEMENT FE ES TO IBM AND THE ASSESSING OFFICER HAS TREATED THE SAME AS THE PAYME NT FOR ACQUISITION OF GOODWILL AND CONSIDERED IT TO BE IN THE NATURE O F CAPITAL EXPENDITURE AND NOT ALLOWABLE U/S 37 OF THE INCOME-TAX ACT. HE SUBMITTED THAT THE DRP HAS MERELY CONCURRED WITH THE AO WITHOUT CONSI DERING THE FACTS AND CIRCUMSTANCES OF THE CASE. THE LEARNED COUNSEL FOR THE ASSESSEE EMPHATICALLY SUBMITTED THAT THE PAYMENT DOES NOT RE SULT IN ANY ENDURING BENEFIT TO THE ASSESSEE BUT IT RESULTS ONL Y IN SMOOTH AND EFFICIENT CARRYING ON OF THE BUSINESS OF THE ASSESS EE. HE SUBMITTED AS PER THE TERMS OF THE AGREEMENT, THE PAYMENT IS FOR MARKETING AND BUSINESS SUPPORT SERVICES FOR A FIXED PERIOD AT AN AGREED CONSIDERATION ITA NO.1457/B/10 17 AND, THEREFORE, IT CANNOT BE TERMED AS GOOD WILL AS IT IS NOT FOR USING ANY BRAND, LOGO OR ANY TRADE MARKS OF IBM. IN SUPP ORT OF ASSESSEES CONTENTION THAT THE PAYMENTS ARE REVENUE IN NATURE, THE LEARNED COUNSEL FOR THE ASSESSEE PLACED RELIANCE UPON THE F OLLOWING DECISIONS : - 1) STATE BANK OF INDIA & ANOTHER VS. MULA SAHAKARI SAK HAR KARKHANA LTD., (2007) AIR 2361 (SC), WHEREIN IT HAS BEEN HELD THAT THE COMMERCIAL DOCUMENTS MUST BE CONSTRUE D BASED ON THE TERMS AND CONDITIONS CONTAINED THEREIN. 22. HE SUPPORT HIS CONTENTIONS AS STATED ABOVE, TH E LEARNED COUNSEL FOR THE ASSESSEE DREW OUR ATTENTION TO CLAUSE 2.1 OF THE MARKETING SUPPORT SERVICES AGREEMENT PLACED AT PAGE NO. 53 O F THE PAPER BOOK TO DEMONSTRATE THE NATURE OF THE SERVICES RENDERED BY THE IBM FOR WHICH THE PAYMENT IS MADE. HE SUBMITTED THAT THE A SSESSEE BEING A PRUDENT BUSINESSMAN HAS ENGAGED IBM TO CARRY ON SUC H MARKETING AND ALLIED SERVICES FOR THE PURPOSE OF MAINTAINING AND INCREASING OPERATING REVENUE OF THE BUSINESS AND, THEREFORE, H AS TO BE TREATED AS REVENUE EXPENDITURE. FOR THE CONTENTION THAT ANY E XPENDITURE INCURRED FOR CARRYING ON BUSINESS EFFICIENTLY IS REVENUE IN NATURE, THE LEARNED ITA NO.1457/B/10 18 COUNSEL FOR THE ASSESSEE HAS PLACED RELIANCE UPON T HE FOLLOWING OTHER DECISIONS - 1) S.A BUILDERS LTD. VS. CIT (2007) - 288 ITR 1 (S C); AND 2) CIT VS. MICO LTD., (2007) - 163 TM 510 (KAR), W HEREIN IT HAS BEEN HELD THAT THE COMMERCIAL EXPEDIENCY OF AN EXPENDITURE IS TO BE DECIDED BY A BUSINESSMAN AND DECISION TO INCUR O R NOT TO INCUR SUCH EXPENDITURE CANNOT BE TESTED ON THE TOUCHSTONE OF STRICT LEGAL LIABILITY TO INCUR SUCH AN EXPENDITURE. 23. HE ALSO PLACED RELIANCE UPON THE DECISION OF H ONBLE SUPREME COURT IN THE CASE OF EMPIRE JUTE MANUFACTURING CO. LTD. VS. CIT REPORTED IN 124 ITR 1, FOR THE PROPOSITION THAT EVE N IF THE ASSESSEE GETS ANY ENDURING BENEFIT FROM THE SAID EXPENDITURE YET IF IT IS FOR THE SMOOTH EFFICIENCY IN CARRYING ON DAY TO DAY BUSINES S OPERATIONS OF THE COMPANY, THEN IT IS IN THE FILED OF REVENUE AND NOT IN THE FILED OF CAPITAL. THUS ACCORDING TO HIM THE EXPENDITURE MUS T BE ALLOWED AS DEDUCTION U/S 37 OF THE INCOME-TAX ACT. 24. THE LEARNED DR HOWEVER PLACED RELIANCE UPON THE ORDER OF THE AO AND THE DRP. ITA NO.1457/B/10 19 25. HAVING HEARD BOTH THE PARTIES AND HAVING CONSID ERED THEIR RIVAL CONTENTIONS AND THE MATERIAL ON RECORD, WE FIND THA T THE QUESTION BEFORE US IS WHETHER THE PAYMENT FOR THE MARKETING SUPPORT AGREEMENT IS REVENUE OR CAPITAL IN NATURE? THE ASSESSEE HAS FILED THE COPY OF THE MARKETING SUPPORT AGREEMENT WHICH IS IN PAPER BOOK NO.2 AT PAGES 23 TO 120. THE ARTICLE 2 OF THE SAID AGREEMENT DESCRI BES THE MARKET SUPPORT SERVICES TO BE DELIVERED BY IBM. FROM A REA DING OF THE SAID SERVICES, IT IS CLEAR THAT THE IBM WAS TO PROVIDE T HE SERVICES TO THE PURCHASER AS PROVIDED IN THE SERVICES DESCRIPTION A TTACHMENT TO FACILITATE THE SALE OF THE PRODUCTS BY THE ASSESSEE AND TO EXTEND SERVICES TO THE CUSTOMERS THROUGH ONE OR MORE OF I TS SUBSIDIARIES OR 3 RD PARTIES UNDER CONTRACT WITH THE SELLER/IBM OR ONE OF ITS SUBSIDIARIES. THUS, IT IS CLEAR THAT THE SERVICES RENDERED BY IBM ARE FOR SMOOTH AND EFFICIENT CARRYING ON OF THE BUSINES S OF THE ASSESSEE FOR A PERIOD OF 5 YEARS. THIS MIGHT GIVE AN ENDURING BENEFIT TO THE ASSESSEE BUT EVERY ACTIVITY WHICH GIVES ENDURING BE NEFIT TO THE ASSESSEE WOULD NOT GET THE CHARACTER OF CAPITAL NAT URE. IT HAS BEEN HELD BY THE VARIOUS HIGH COURTS IN A CATENA OF DECISIONS THAT THE ENDURING BENEFIT IS NOT THE ONLY CRITERIA TO DECIDE THE NATU RE AND CHARACTER OF AN EXPENDITURE. THE NECESSARY TEST IS WHETHER IT IS F OR ACQUISITION ITA NO.1457/B/10 20 OF ANY CAPITAL ASSET OR FOR THE PURPOSE OF CARRYING ON THE BUSINESS, DERIVING REVENUE FROM IT. THE MARKETING SUPPORT SERVICES CANNOT HOWEVER BE CONSIDERED AS ACQUISITION OF A CA PITAL ASSET. THE SUPPORT SERVICES ARE FOR THE PURPOSE OF SALE OF THE PRODUCTS MANUFACTURED BY THE ASSESSEE AND, THEREFORE, IT IS CLEARLY ESTABLISHED THAT IT IS FOR EFFICIENT RUNNING OF THE BUSINESS AN D DERIVING REVENUES THERE-FROM. IN SUCH CIRCUMSTANCES, WE ARE INCLINED TO HOLD THAT THE FEES PAID BY THE ASSESSEE FOR MARKETING SUPPORT SER VICES RENDERED BY IBM, IS CLEARLY REVENUE IN NATURE AND IS ALLOWABLE AS DEDUCTION U/S 37 OF THE INCOME-TAX ACT. 26. IN THE RESULT, THIS GROUND OF APPEAL IS ALLOWED . 27. AS REGARDS GROUND NO.11, THE BRIEF FACTS OF THE CASE ARE THAT THE ASSESSEE, AFTER ACQUIRING THE BUSINESS OF PCS AND L APTOPS DIVISION FROM IBM DURING THE PREVIOUS YEAR, CONTINUED TO CARRY O N MANUFACTURING AND TRADING OPERATIONS OF PCS AND LAPTOPS USING THE SAME FACILITY AND SALES HAVE BEEN MADE THROUGH THE SAME DEALERSHIP NE T WORK USED BY THE IBM IN ITS BUSINESS PRIOR TO THE ACQUISITION. THE FUTURE BILLING ADJUSTMENT RESERVE OF RS.12,501,000/- WAS A LIABILI TY TOWARDS VARIOUS CLAIMS/SPECIAL DISCOUNTS PAYABLE TO DISTRIBUTORS/ DEALERS OF IBM ITA NO.1457/B/10 21 INDIA, WHEREAS THE ACTUAL PAY OUTS RELATING TO THE PERIOD UPTO THE EFFECTIVE DATE OF TAKE OVER I.E 11 TH MAY, 2005 WAS 23,16,79,000/- AND ACCORDINGLY, THE DIFFERENCE AMOUNTING TO RS.21,91,7 8,000/- HAS BEEN CHARGED TO THE PROFIT AND LOSS ACCOUNT AND THIS ASP ECT WAS SPECIFICALLY MENTIONED IN THE NOTES TO THE FINANCIALS OF THE ASS ESSEE. THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE ABOVE E XPENDITURE HAS BEEN INCURRED OVER AND ABOVE THE ESTIMATED LIABILITY WHI CH WAS TAKEN OVER FROM IBM AND, THEREFORE, RELATES TO THE CARRYING ON OF THE ASSESSEES BUSINESS AND SUCH EXPENDITURE HAS BEEN CLAIMED AS R EVENUE EXPENDITURE. THE LEARNED COUNSEL FOR THE ASSESSEE FURTHER SUBMITTED THAT AS REGARDS DUTY FREE REPLENISHMENT CERTIFICATE S RECEIVABLE ARE CONCERNED, THEY WERE ALSO TAKEN OVER FROM IBM INDIA AND WERE AVAILABLE FOR UTILIZATION AGAINST IMPORT OF INPUTS USED IN THE MANUFACTURE OF GOODS WITHOUT PAYMENT OF CUSTOMS DUT Y. THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE GOVT. O F INDIA VIDE NOTIFICATION NO. 24/2005 CUSTOMS DATED MARCH 1, 2 005 HAS EXEMPTED CUSTOM DUTY ON ALL IMPORTS OF COMPUTER PAR TS AND, THEREFORE, THE DFRC RECEIVABLE WAS NO LONGER UTILIZABLE AND WA S HENCE WRITTEN OFF AND CHARGED TO THE PROFIT AND LOSS ACCOUNT AS R EVENUE EXPENDITURE, SINCE THE ASSESSEE WAS ALSO IN THE SAME LINE OF BUS INESS. THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED THAT THESE TWO E XPENSES HAVE BEEN ITA NO.1457/B/10 22 DISALLOWED BY THE AO ON THE GROUND AND THESE EXPEND ITURE ARE INCURRED BY IBM AND NOT BY THE ASSESSEE FOR THE PUR POSE OF ITS BUSINESS AND THAT THESE LIABILITIES MUST HAVE BEEN INCLUDED IN THE PURCHASE PRICES PAID TO IBM. HE SUBMITTED THAT THE AO HELD THAT TO CLAIM ANY EXPENDITURE AS WRITTEN OFF , IT MUST BE T AXED AS INCOME IN THE HANDS OF THE ASSESSEE IN THE PREVIOUS YEARS AND AS THE ASSESSEE HAS NOT OFFERED THE ABOVE EXPENDITURE AS INCOME FOR THE EARLIER YEARS, THE SAME CANNOT BE ALLOWED IN THIS YEAR. THE LEARNED CO UNSEL FOR THE ASSESSEE FURTHER SUBMITTED THAT SINCE THE DEALERS H AVE NOT SUBMITTED THE CLAIM IN FULL TO IBM BEFORE THE ACQUISITION OF BUSINESS BY THE ASSESSEE, THE IBM HAS FAILED TO RECORD OR RECOGNIZE SUCH LIABILITY IN ITS BOOKS OF ACCOUNTS AND THE ASSESSEE HAS INCURRED THE EXPENDITURE AFTER ITS TAKING OVER OF BUSINESS ONLY TO PROTECT ITS BUS INESS INTEREST AND FOR SMOOTH FUNCTIONING OF THE ROUTINE BUSINESS OPERATIO NS OF THE ASSESSEE. HE SUBMITTED THAT THE FUTURE BILLING ADJUSTMENT IS DONE DUE TO COMMERCIAL EXPEDIENCY, AS THE ASSESSEE REQUIRES THE SERVICES OF THE BUSINESS PARTNERS/DISTRIBUTORS AND DEALERS TO CONTI NUE AND CARRY ON THE BUSINESS ON REGULAR BASIS AND, THEREFORE, IT MUST B E ALLOWED AS A DEDUCTION. IN SUPPORT OF ITS CONTENTIONS, HE PLACE D RELIANCE UPON THE DECISION OF THE HONBLE SUPREME COURT IN THE CASE O F CIT VS. VEERABHADRA RAO, K KOTESWARA RAO AND CO. (1985) 1 55 ITR 152 ITA NO.1457/B/10 23 (SC), WHEREIN IT HAS BEEN HELD THAT IN CASE OF SUCC ESSION OF THE BUSINESS, THE SUCCESSOR STEPS INTO THE SHOES OF PRE DECESSOR, AND, THEREFORE, THE TREATMENT MUST BE SIMILAR, AS IF SUC H CLAIM HAS BEEN MADE ON THE PREDECESSOR HIMSELF. HE ALSO PLACED RE LIANCE UPON THE DECISION OF THE HONBLE MADRAS HIGH COURT IN THE CA SE OF CIT VS. GEORGEPOLOUS (1984) 146 ITR 380 (MAD), WHEREIN UNDE R SIMILAR CIRCUMSTANCES, IT WAS HELD THAT SUCH PAYOUTS FOR PR OTECTING THE BUSINESS INTERESTS MUST BE ALLOWED AS REVENUE EXPEN DITURE, EVEN THOUGH THE ASSESSEE WAS NOT OBLIGATED TO MAKE SUCH PAYMENT. IN VIEW OF THE SAME, HE PRAYED THAT THE ABOVE PAYMENTS SHOU LD BE ALLOWED AS REVENUE EXPENDITURE. 28. THE LEARNED DR HOWEVER SUPPORTED THE ORDERS OF THE AUTHORITIES BELOW AND SUBMITTED THAT THESE EXPENDITURE ARE RELA TING TO THE PERIOD BEFORE ACQUISITION OF THE BUSINESS BY THE ASSESSEE AND, THEREFORE, IT CANNOT BE CLAIMED BY THE ASSESSEE FOR THE RELEVANT ASSESSMENT YEARS. 29. HAVING HEARD BOTH THE PARTIES AND HAVING CONSID ERED THE RIVAL CONTENTIONS AND JUDICIAL PRECEDENTS ON THE ISSUE, W E FIND THAT WHEN THE ASSESSEE HAS TAKEN OVER THE DIVISION OF DESK TOPS A ND LAP TOPS FROM IBM, THE ASSESSEE HAS ALSO TAKEN OVER THE LIABILITI ES, WHICH INCLUDE THE ITA NO.1457/B/10 24 COMMISSION AND DISCOUNTS TO THE DEALERS. AS HELD B Y THE HONBLE SUPREME COURT IN THE CASE VEERABHADRA RAO (CITED S UPRA), THE SUCCESSOR OF A BUSINESS STEPS INTO THE SHOES OF ITS PREDECESSOR AND IS LIABLE TO MEET ANY CLAIMS AGAINST THE PREDECESSOR. SIMILARLY AS HELD BY THE HONBLE MADRAS HIGH COURT IN THE CASE OF GEO RGEOPOLOUS (CITED SUPRA) ANY EXPENDITURE INCURRED BY THE ASSES SEE TO PROTECT ITS BUSINESS AND TO CARRY ON ITS BUSINESS IN A SMOOTH M ANNER IS TO BE ALLOWED AS REVENUE EXPENDITURE. IN THE CASE BEFORE US, NO DOUBT THE FUTURE ADJUSTMENT BILLING IS RELATING TO THE SALES MADE BY THE IBM DURING THE EARLIER FINANCIAL YEARS, BUT THE ASSESSE E IS BOUND TO CARRY ON BUSINESS WITH THE SAID DEALERS IN FUTURE AND FOR TH AT PURPOSE IT HAS TO MAINTAIN CORDIAL AND GOOD RELATIONSHIP WITH THE SAI D DEALERS. FOR SUCH PURPOSE, THE ASSESSEE IS BOUND TO MAKE PAYMENTS TO MAINTAIN THE BUSINESS RELATIONS WITH THE DEALERS AND SUCH PAYMEN TS HAVE TO BE CONSIDERED AS BUSINESS EXPENDITURE OF THE ASSESSEE. 30. COMING TO THE DUTY FREE REPLACEMENT CERTIFICAT ES (DFRC), WE AGREE WITH THE CONTENTIONS OF THE LEARNED COUNSEL F OR THE ASSESSEE THAT ON THE NOTIFICATION OF THE CENTRAL GOVT. WHEN ALL T HE IMPORTS OF THE COMPUTER PARTS ARE CUSTOM FREE, THESE CERTIFICATES BECOME USELESS AND CANNOT BE UTILIZED BY THE ASSESSEE. HOWEVER THEY H AVE ALREADY ITA NO.1457/B/10 25 ENTERED THE BOOKS OF THE ASSESSEE AS CURRENT ASSET S AND, THEREFORE, THE ASSESSEE HAD TO WRITE THEM OFF AND CLAIM THE SAME A S REVENUE EXPENDITURE. 31. IN VIEW OF THE SAME, WE ARE INCLINED TO ALLOW T HIS GROUND OF APPEAL OF THE ASSESSEE. 32. AS REGARDS GROUND NO.12 IS CONCERNED, WE FIND T HAT IT IS CONSEQUENTIAL IN NATURE AND THEREFORE, THE AO IS DI RECTED TO GIVE CONSEQUENTIAL RELIEF TO THE ASSESSEE IF ANY. 33. IN THE RESULT, THE APPEAL FILED BY THE ASSESSEE IS PARTLY ALLOWED. ORDER PRONOUNCED IN THE OPEN COURT ON 16TH MAR, 2012. SD/- SD/- (N BARATHVAJA SANKAR) (P MADHAVI DEVI) VICE PRESIDENT JUDICIAL MEMBER VMS. BANGALORE DATED : 16/03/2012 ITA NO.1457/B/10 26 COPY TO : 1. THE ASSESSEE 2. THE REVENUE 3.THE CIT CONCERNED. 4.THE CIT(A) CONCERNED. 5.DR 6.GF BY ORDER ASST. REGISTRAR, I TAT, BANGALORE.