Royalty expenditure towards license right to use the know-how is revenue in nature

Mercedes-Benz India Pvt. Ltd. Vs Dy. C.I.T. (ITAT Pune)

Held that the assessee has secured the license right to use the know-how for the period of the agreement and the royalty expenditure in this regard is therefore revenue in nature.

Facts-

The assessee, Mercedes Benz India Pvt. Ltd., is a company incorporated under the provisions of the Companies Act, 1956 and is mainly engaged in the manufacture and sale of Mercedes Benz passenger cars in the Indian market MB India currently manufacturing E.C.S. GL class and CLA class of passenger cars in India. Pursuant to a ‘Technology License Agreement’ entered by the Appellant with Daimler AG, it has paid an amount of Rs. 12,51,11,877/- as royalty to Daimler AG. AO disallowed the royalty expenses by considering it to be a capital expenditure.

Conclusion-

Held that from the terms and conditions of the agreement, it is clear that MB India’s rights ends on termination of the agreement. It also evident that MB India has neither acquired any assets on an outright basis nor secured any enduring advantage. The benefit secured by MB India is essentially a license right to use the know-how for the period of the agreement and the royalty expenditure in this regard is therefore revenue in nature.

FULL TEXT OF THE ORDER OF ITAT PUNE

This Appeal preferred by the assessee emanates from the direction of the learned Dispute Resolution Panel (hereinafter referred to as ‘DRP‘ for short) dated 29-11-2016 for A.Y. 2012-13 as per the following grounds of appeal.

“Based on the facts and circumstances of the case and in law, the Appellant respectfully craves to prefer an appeal against the order dated 30 January 2017 passed by the learned Deputy Commissioner of Income-tax, Circle – 9, Pune (hereinafter referred as ‘the learned Assessing Officer’) (received by the Appellant on 31 January 2017) under section 143(3) read with section 144C(13) of the Income-tax Act, 1961 (‘the Act’) on the following grounds which are independent of and without prejudice to each other:

On the facts and circumstances of the case and in law, the learned Assessing Officer:

A. Grounds of appeal in respect of Transfer pricing adjustment

Ground No.1-Transfer pricing adjustment should be deleted as being bad in law

Erred in making the reference to the TPO without proper application of mind to the facts on records, without recording his reasons for any necessity or expediency, without legal and valid approval of CIT and ignoring the conditions stipulated in section 92C(3)/92CA(1) and hence, the same is not in accordance with the provisions of the Act.

The transfer pricing adjustment and the Transfer Pricing Order passed should be quashed as being bad in law or illegal or void ab initio.

Ground No.2 – General ground related to Transfer pricing adjustment amounting to Rs. 110,33.85,000 Erred in law and in circumstances by not considering the transfer pricing analysis documented in transfer pricing report for A Y 2012-13.

Ground No.3 – Rejecting the combined transaction approach

Erred in law and in facts by rejecting the combined transaction approach adopted by the Appellant at entity level for benchmarking the various international transactions entered into by the Appellant.

Ground No.4 – Rejecting all the comparable companies

Erred in law and in facts by rejecting all the companies identified by the Appellant in the transfer pricing study report of A Y 2012-13 as comparable companies.

Ground No.5 – Comparing the gross margin of controlled transaction with another controlled transaction

Erred on the facts and in law by comparing the gross margin from international transaction pertaining to import of CBUs with the international transaction pertaining to import of spares (i.e. both being controlled transactions of the Appellant itself).

Ground No.6 – Applying Resale Price Method and comparing gross margin from international transaction pertaining to import of CBUs with the international transaction pertaining to import of Spares

Erred on the facts and in law by applying Resale Price Method (‘RPM’) and comparing gross margin of controlled transaction of import of Completely Built Unit cars (‘CBUs’) with gross margin of functionally non comparable controlled transaction of import of spares of Appellant.

Ground No.7 – Adjustment for differences in function, asset and risk profile

Erred in law and facts in making transfer pricing adjustment to the purchase price of CBUs without granting adjustment to account for differences in functions, assets and risks of the spares segment vis a-vis CBU segment.

Ground No.8 – Rejecting the separate Transaction Net Margin Method search

Erred in facts and in circumstances of the case by rejecting the separate TNMM search provided (on a without prejudice basis) by the Appellant for separate benchmarking of the international transaction of import of CBUs.

Ground No.9 – Rejecting certain additional Indian companies and accepted certain inappropriate Indian companies as com parables

Erred on facts and in law by rejecting certain additional Indian companies identified by the Appellant during the course of assessment proceeding on without prejudice basis and also erred in accepting certain inappropriate Indian companies rejected by the Appellant as not comparable.

Ground No. 10 – Computation of operating margin of the Appellant at entity level, without taking into consideration the excess custom duty paid on imports by Appellant vis-a-vis comparable companies

Erred on the facts of the case and in law by computing the operating margin of the Appellant without taking into consideration the excess custom duty paid on imports by MB India.

Ground No. 11 – Computation of operating margin of the Appellant at entity level, without excluding additional cost on account of abnormal foreign exchange rate movement

Erred on the facts of the case and in law by computing the operating margin of MB India without factoring the effect of abnormal foreign exchange movement on its total cost.

Ground No. 12 – Computation of operating margin of MB India at entity level without excluding extra-ordinary expenses on account of excess demurrage/detention charges and litigation claim

Erred on the facts of the case and in law by computing the operating margin of the Appellant at entity level without excluding extra-ordinary demurrage and litigation expenses incurred by MB India.

Ground No. 13 – Transfer pricing adjustment to be limited to the international transactions with AEs only (without prejudice ground)

Erred in facts and in the circumstances of the case by not restricting! proportionating the transfer pricing adjustment to the international transaction with AEs only while making adjustment at entity level.

Ground No. 14 – Inappropriate use of single year data

Erred on the facts and in circumstances of the case and in law by not considering multiple year data for determining the arm’s length price.

Ground No. 15 – Transfer pricing adjustment without giving benefit of +/-5 percent as available under proviso to section 92C(2) of the Act

Erred in computing the arm’s length price of the international transactions, without taking into account the benefit of +/- 5 percent variation from transfer price as available under proviso to section 92C(2) of the Act.

B. Grounds related to corporate tax adjustments

Ground No. 16 – Disallowance of Royalty expenditure Erred on the facts and in circumstances of the case in disallowing the royalty expenditure of Rs 12,51,11,887 as capital expenditure for AY 2012-13.

Ground No. 17 – Disallowance of Homologation expenditure

Erred on the facts and in circumstances of the case in disallowing the expenditure on homologation of Rs 2,34,85,773 as capital expenditure for AY 2012-13.

2. That before coming into the facts of the case let us understand background of the business model of the assessee i.e. Mercedes Benz India Pvt. Ltd. Mercedes Benz is a company incorporated under the provisions of the Companies Act, 1956 and is mainly engaged in the manufacture and sale of Mercedes Benz passenger cars in the Indian market MB India currently manufacturing E.C.S. GL class and CLA class of passenger cars in India.

Import of CBUs

Generally, an automobile company starts with importing cars in the form of Completely Built units (CBUs) for three reasons:

For assessing and penetrating into the market and then subsequently, depending upon the market situation start importing cars in the form of semi knocked down (‘SKD‘) condition, complete knock down (‘CKD‘) condition and then eventually operating at part level.

For bringing in new products available with AE as CBU, which will take time to supply the same in SKD / CKD / Parts level and also some times to bridge a sudden gap of demand and manufacturing capacity.

For bringing in niche models which will be sold in few numbers and may not be currently viable to manufacture in India but important to offer entire range to the customers. With respect to activity of import of CBUs, MB India wishes to submit that MB India manufactures S- Class, E-Class and C-Class range of Mercedes-Benz passenger cars in India. In addition to manufacturing operations, MB India also imports certain Mercedes-Benz models in the niche segment for resale in India.

With respect to activity of import of CBUs, MB India wishes to submit that MB India manufactures S- Class, E-Class and C-Class range of Mercedes-Benz passenger cars in India. In addition to manufacturing operations, MB India also imports certain Mercedes-Benz models in the niche segment for resale in India.

Such imports are restricted to models not manufactured by MB India as, given the current demand, it is not commercially sustainable to manufacture the same. Such import of CBUs is carried out with the view to cater and maintain the markets for the Mercedes-Benz models which are not manufactured by MB India. This ensures that the customer continues to use Mercedes-Benz cars and could be targeted for local manufacturing cars in the future.

Thus, with respect to volume models like the E-Class & C-Class models of cars manufactured by MB India, the Appellant submits that these models followed the path of CBUs / SKD- CKD – Part level sale. Further, MB India submits that it has now started manufacturing M-Class and GL-Class models which were earlier imported as CBUs in FY 2011-12. The manufacturing of M Class and GL class started in FY 2012-13 and FY 2013-14 respectively and the models which are currently imported in the form of CBUs are A-Class, B-Class models, etc.

Also, it is pertinent to note that there is always a time lag between the introduction of a new model in the international market and the commencement of manufacturing in India by the company. To shorten the time lag and generate a demand, CBUs are imported to meet the market requirements till local production starts in the company. Further, whenever there is higher market demand than the planned local production, CBUs are imported to bridge the gap between demand and supply. This is required as the lead time between planning and manufacturing cycle is more than six months.

In view of the above, the Appellant submits that import and sale of CBUs is important for assessing the market condition for a particular range of cars which could be targeted for manufacturing by MB India in future or to bring in niche models which will be sold in few numbers and not currently economically viable to manufacture in India. Further, CBU imports are made to bring new products available with AE as CBU, but will take time to supply the same in SKD / CKD / Parts level and also some times to bridge a sudden gap of demand and manufacturing capacity.

Warranty commitments/replacements of spare parts

In common parlance, automobile manufacturer generally sells the car to its dealers, who in turn sell cars to customers. Generally, the sale of car is covered by a manufacturer‘s warranty provided for 1 or 2 years and the charges towards that warranty is embedded in the sale price.

Similarly, in case of MB India, when the Appellant sells its cars to various customers through its dealers, they have an attached warranty condition in respect of cars manufactured as well as imported as CBUs i.e. in the event of failure of any part / component, a faulty design/manufacture, defects arises which were not originally visualized, then in such case MB India would provide for replacement of spare parts. MB India provides warranty for 2 years and additionally for 1 year at no extra cost. Further, MB India provides extended warranty for fourth year on payment, under Star Care Program.

This warranty is administered through dealers who addresses the warranty claims of the customers and resolves the same. The dealer recovers the warranty charges (i.e. cost of labour + cost of the spare parts replaced/ repaired + applicable taxes) from MB India.

Further as per the dealership agreement, it is clearly evident that

• As per Article 2, Para 1, MB India provides spares parts and accessories to the dealers in respect of cars manufactured as well as imported as CBUs.
• Further, as per Article 6, Para 6.2, dealer is responsible to ensure that the warranty claims with respect to the goods are settled properly and without delay and the warranty work shall consist either of replacement or repair of parts.
• Also, as per Article 6, para 6.4, the dealer shall use only the spare parts supplied by MB India in repairing and maintaining the car manufactured as well as imported as CBUs and also maintain adequate stock of spare parts.

Also, your Honours will agree to the fact that a customer who buys a Mercedes-Benz car will buy spares from the Appellant to ensure genuineness of the parts and thereby enhanced performance of the vehicle. On the other hand, if the Appellant doesn‘t ensure supply of adequate spare parts, its after-sale services would suffer resulting in a loss of reputation. Thus, the sale of manufactured/traded cars would result in subsequent generation of revenue from sale of spare parts. Without this activity, the Appellant could not have independently carried out the activity of import and sale of spares.

Further, keeping in view the intense competitive environment in the auto industry, it makes commercial sense to sell the cars at a competitive price, which could be compensated from the premium pricing on sale of spares, resulting in higher margins from sale of spare parts compared to sale of CBUs.‖

3. The brief facts in this case are that:

The Assessee had filed the return of income on 29 November 2012 reporting taxable income of Rs.33,77,27,590 (deemed income as per section 115JB Minimum Alternate Tax (‘MAT‘) provisions of the Act of Rs 32,09,79,384). Thereafter, the assessee also filed a revised return on 29 March 2014 declaring the taxable income of Rs.33,77,27,590 (deemed income as per section 115JB Minimum Alternate Tax (‘MAT‘) provisions of the Act of Rs 27,34,29,371). The learned Assessing Officer (AO) had made various additions/disallowance vide draft assessment order dated 29 February 2016, thereby assessing the total income at Rs.175,07,39,160 under the provisions of the Act.

4. Being aggrieved by the additions/disallowances made by the learned AO in the draft assessment order, the assessee preferred an appeal before the Dispute Resolution Panel (‘DRP‘). Hon‘ble DRP after going through the submission/ details provided by the assessee adjudicated the issues under appeal, thereby granting partial relief to the assessee. Post DRP directions, the AO passed the final order to give effect to DRP directions (under section 143(3) r.w.s. 144C(13) of the Act) and thereby assessing the total income at Rs.144,56,24,160/-

5. Background relating to transfer pricing adjustment

MB India had entered into international transactions of import of raw materials, import of spare parts, import of Completely Built Units (‘CBUs‘), import of capital goods, payment of royalty, payment for technical services availed, receipt of commission, reimbursement/ recovery of expenses, recovery of warranty, etc., with its Associated Enterprise (‘AE‘) for AY 2012-13. MB India is primarily engaged in manufacturing activity for which it imports raw material, capital goods and makes payment for services / know-how. Further, as a part of its manufacturing and sales activity it needs to:

a) import CBUs which are not locally manufactured which provides the customers access to the global range of cars and thereby build its customer base for potential sale of locally manufactured cars; and

b) Service its customers in respect of the cars manufactured in India as well as the cars imported as CBUs, for which it imports spares for after sale services and warranty commitments.

(a) Since the above transactions are germane to the main business of MB India viz manufacturing of passenger cars, the said international transactions were considered as being closely linked as a part of MB India‘s manufacturing activity and accordingly, have been aggregated for transfer pricing analysis and evaluated by adopting a ‘Combined Transaction Approach‘. MB India accordingly identified the Transactional Net Margin Method (hereinafter referred to as ‘TNMM‘) as the most appropriate method to benchmark its international transactions for AY 2012-13. The international transaction entered into by MB India during the year is as follows:

Sr. No.	Description of the transactions	Amount (Rs)
1	Import of raw materials	9,472,371,698
2	Import of spare parts	968,834,082
3	Import of Completely Built Units (CBUs)	2,123,461,081
4	Import of capital goods	55,911,021
5	Payment of royalty	119,154,170
6	Payment for Technical services	93,132,406
7	Receipt of commission	5221,549
8	Recovery of Expenses	7,86,36,505
9	Warranty Recovery	8,69,03,968
10	Reimbursement of Expenses	14,59,41,110
11	Total	1314,95,67,591

(b) For the application of TNMM, MB India had conducted search for comparable companies using multiple year data (current year and prior two years), a summary of which is tabulated below:

Database used for research	PLI used	No of comparable companies	Margin of comparable companies	Margin  of MB India
Dow Jones	Net operating profit/ Operating Income	9 (Asia Pacific regional comparables)	2.97 %	1.27%*

* – The operating margin of MB India was computed post considering certain costs as non-operating in nature

(c) Since the operating margin earned by MB India was within the ± 5% range (permitted under the Act) of arithmetic mean of the operating margins earned by comparable companies, it was concluded that the various international transactions undertaken by MB India were at arm‘s length.

However, the learned TPO did not accept the search conducted by the assessee in its transfer pricing study and rejected all the comparables identified by the assessee citing following reasons:

• Use of consolidated financials;
• Annual report not available/ not available in English Language;
• Comparables operating in different geographical market.

(d) Further, during course of transfer pricing assessment proceedings (‘TP Proceedings), upon the request of the learned TPO and on without prejudice to the assessee‘s approach in the TP Study, an alternative search process considering Indian companies engaged in the manufacturing of cars after eliminating the companies having related party transactions (‘RPT‘) more than 25% were submitted vide submission dated 29 September 2015. The following companies were identified as comparable to the assessee:

Sr. No	Name of the company	Operating margin FY 2011­12
1	Force Motors Ltd	2.99%
2	Hindustan Motors Ltd	-22.03%
3	Premier Ltd – Automotive Segment	3.14%
	Arithmetic Mean	–5.30%

(e) The arithmetic mean of operating margin of comparable companies worked to -5.30% as against unadjusted MB India‘s margin of 0.04% (rejected the non-operating items considered by MB India resulting into reduction of operating margin from 1.27% as per TP Study report) at entity level and accordingly, since the unadjusted margins earned by MB India were higher than the arithmetic mean of the comparable companies, the international transactions was concluded to be at arm‘s length price.

(f) However, the learned TPO rejected the Indian comparable companies (Force Motor Limited and Hindustan Motor Limited) identified by appellant and added Tata Motors and Mahindra and Mahindra as comparable by increasing the RPT filter from 25% to 30%.

(g) Further, the learned TPO did not accept approach followed by MB India of benchmarking international transactions following Combined Transaction Approach using the TNMM as the most appropriate method. The approach followed by the TPO is summarised below:

The learned TPO benchmarked the international transaction pertaining to import of CBUs using Resale Price method (hereinafter referred to as ‗RPM‘) by inappropriately comparing gross margin earned from another controlled transaction of MB India (import of spares). Thus, the learned TPO compared gross margin earned from spares (i.e. 26.32%) with the gross margin earned from trading of CBUs purchased and sold during the year (i.e. 6.86%) and made differential adjustment to the international transaction of import of CBUs.

Further, the learned TPO also separately benchmarked the entity level operating margins of MB India with the operating margins of Indian comparable companies (as mentioned above). The arithmetic mean of operating margin of comparables identified by the Learned TPO is 5.99% vis-à-vis 2.31% of MB India (after considering adjustment made for CBU segment).

The summary of the transfer pricing adjustments is tabulated below:

Sr. No	Particulars	AY 2012-13 (Rs)
1	Adjustment pertaining to CBU segment	53,81,00,000
2	Adjustment at entity level	87,04,00,000
	Total	140,85,00,000

Aggrieved by the order, assessee filed an appeal before the Hon‘ble DRP for the aforesaid adjustments.

Proceedings before the Hon’ble DRP

(a) The Hon‘ble DRP accepted Force Motors Ltd., as comparable company to MB India. However, for other comparables in dispute, Hon‘ble DRP upheld the order of TPO. The final set of comparable as per Hon‘ble DRP is tabulated below:

Sr. No	Name of the company	Operating margin AY 2012­13
1	Premier Ltd –  Automotive Segment	3.14%
2	Force Motors Ltd	2.99%
3	Mahindra & Mahindra Ltd	9.19%
4	Tata Motors Ltd	4.83%
	Arithmetic Mean	5.24%

(b) Further, Hon‘ble DRP directed the learned AO to exclude the royalty expenditure and homologation cost disallowed during the assessment proceedings while computing the operating margin of the manufacturing activity of the Appellant for application of TNMM. Hence, the revised operating margin of Appellant, post direction works out to 0.58%.

(c) For other grounds raised by assessee, the Hon‘ble DRP upheld the contentions of TPO.

The summary of transfer pricing adjustment, post DRP directions is tabulated below:

Sr. No.	Particulars	AY 2012-13 (Rs)
1	Adjustment   pertaining segment to CBU	53,81,00,000
2	Adjustment at entity level	56,52,85,000
	Total	110,33,85,000

(d) Further, the Ld. AO in its Draft Assessment Order disallowed the royalty expenditure of INR 12,51,11,877 by considering it to be a capital expenditure. The Ld. AO relied on the assessment orders for AY 2004-05 to AY 2011-12 where similar disallowances were made. Reliance was also placed on the Hon‘ble DRP‘s directions pertaining to AY 2007-08 to AY 2011-12 where the disallowances were upheld by the Hon‘ble DRP.

(e) Similarly, the Ld. AO also disallowed the expenditure incurred on Homologation amounting to INR 2,34,85,773 by considering it to be a capital expenditure.

7. That referring to the grounds of appeal filed in the appeal memo, learned Senior Counsel submitted that ground Nos. 1 and 2 are general grounds. Ground No. 3 is with regard to rejecting the combined transaction approach. Ground No. 5 is with regard to comparing gross margin of controlled transaction with another controlled transaction. Ground No. 6 is with regard to applying resale price method and comparing gross margin from international transaction pertaining to import of CBUs with the international transaction pertaining to import of spares. Ground No. 7 is with regard to adjustment for differences in function, asset and risk profile of the spares segment vis-à-vis CBU segment. Ground No. 8 is with regard to rejecting the separate transactional net margin method search. That apart from submissions made by the assessee on this ground, it was submitted by the learned Senior Counsel that all the above mentioned grounds of appeal are covered by the decision of Pune Bench of the Tribunal in assessee‘s own case, lead year being A.Y. 2005-06 (ITA No. 1083/PN/2013, ITA No. 1107/PN/2013 and C.O. No. 60/PN/2014 which is annexed at pages 23 to 65 in the paper book wherein the Co-ordinate Bench of the Tribunal in its decision has analyzed the business model of the assessee in detail along with rational for the aggregation approach followed by the assessee to bench mark its international transaction. Thereafter, the assessee submits that since all the international transactions entered into by MB India with its AEs are germane to the main business of MB India, the said international transactions were considered as being closely linked as a part of MB India‘s manufacturing activity and accordingly, have been aggregated for transfer pricing analysis and evaluated by adopting a ‗Combined Transaction Approach‘. MB India identified TNMM as the most appropriate method. However, the learned TPO did not accept the approach followed by MB India of benchmarking international transactions following Combined Transaction Approach and benchmarked the international transaction pertaining to import of CBUs using RPM by inappropriately comparing gross margin from CBUs segment (6.86%) with the spares segment (26.32%).

(a) The learned TPO justified the use of RPM with the following contentions:

• The learned TPO stated that the nature of transaction or the quantum of transaction and characteristics of the transaction are similar as it employs common method of sale for CBU and spare parts.
• The functions performed and risks undertaken for these two segments of Assessee’s business is same as because the Assessee has to assess the requirement of spare parts and those of CBUs and accordingly place orders with their principals and sell it to dealers.
• The TPO contended that difference if any in case of the assets employed on account of lesser requirement of storage space, inventory maintenance, marketing cost, labour cost etc. could have a bearing on the net profit earned by the Assessee but the same cannot affect the Assessee‘s gross earnings.

(b) Import of CBU is closely linked with the manufacturing activity of MB India

MB India has set up a manufacturing unit in India to manufacture Mercedes cars. Further, as a part of its manufacturing and sales activity it also needs to:

import CBUs which are not locally manufactured which provides the customers access to the global range of cars and thereby build its customer base for potential sale of locally manufactured cars; and

Service its customers in respect of the cars manufactured in India as well as the cars imported as CBUs, for which it imports spares for after sale services.

As discussed above and taking into consideration the business model of MB India, the Appellant submits that import of CBU and spares is closely linked to manufacturing activity.

(c) To support the aggregation of transaction approach, MB India relies on the following:

• Section 92(1) states ―Any income arising from an international transaction shall be computed having regard to the arm‘s length price‖.
• Under section 92B of the Act meaning of expression ‗international transaction‘ is provided i.e. transaction between two or more associated enterprise and section 92F(v) defines, transaction to include ―an arrangement, understanding or action in concert
• Further, Rule 10A(d) explains the meaning of the expression “transaction” as follows:

“transaction includes number of closely linked transactions”

(d) From the above meaning of the expression “transaction”, legislature intends to include transactions of similar nature which are closely linked to each other as a single transaction.

(e) Further, Rule 10B(1) states, ” For the purposes of sub-section (2) of section 92C, the arm‟s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely..”

(f) From the above extract of Rule 10B and the meaning of the word transaction specified in the Rules, for the purpose of analysing the arm’s length price, legislature intends that an Appellant should treat all the closely linked transaction as one transaction and perform a common analysis for these transactions, by following any of the prescribed method.

(g) MB India further draws reference from Accounting Standard 17 (Refer page 530-531 of Paper book) in support of its contention of aggregation of various international transactions.

(h) Inappropriately comparing gross margin of controlled transaction with another controlled transaction

The Assessee submits that for application of RPM method, the price charged in a comparable uncontrolled transaction (after requisite adjustments for differences) is taken to be an ALP. Since the activity of trading in spares parts is between the associated enterprises, it cannot be said to be an ―uncontrolled transaction‖ and considering the legislation, it is not possible/ permissible to compare the said controlled transaction for benchmarking international transaction of import of CBUs.

(i) With respect to issue of controlled transaction, the Appellant places reliance on the following:

• Rule 10B(2) of the Rules provides that comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following:

(a) The specific characteristics……

(b) The functions performed…..

(c) The contractual terms……

(d) Conditions prevailing in the markets

• Rule 10B (3) of the Rules provides that an uncontrolled transaction shall be comparable to an international transaction if:

(a) None of the differences, if any, between the transactions

(b) Reasonably accurate adjustments…..

• Rule 10B (4) of the Rules provides that the data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into……

(j)  Basis the above, the assessee submits that the learned TPO has erred in comparing the controlled transaction of import of CBUs with another controlled transaction of import of spares to determine the arm‘s length price of the international transaction of import of CBU.

(k) Inappropriately selection of RPM as the most appropriate method

The learned TPO accepted TNMM as the most appropriate method in respect of all the international transactions undertaken by MB India except for import of CBUs which is benchmarked by learned TPO using RPM method. In this regard, the Assessee submits that RPM is not applicable because of following reasons:

(l) Same or similar products to be compared while using RPM

• Rule 10B (1) of the Income-tax Rules provides as follows:

For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :—

b) resale price method, by which,—

(i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified;

(ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions;

• The Assessee placed reliance on the above and submits that the basic requirement for using RPM as the most appropriate method for benchmarking the arm‘s length price is that the products to be compared should be same or similar, whereas the learned TPO has compared CBUs (i.e. complete cars) with spares (parts of cars), which are two very different products.

(m) Non-availability of comparable data

The Assessee has mentioned the following in its TP Study report with regard to selection of most appropriate method for benchmarking the international transaction of import of CBUs,

(n) “As regards import of CBUs for resale, the search process as detailed hereunder did not yield any data of Indian companies engaged in distribution of products similar to those of MB India‟s CBUs. All the companies found as broad comparables in the Prowess database failed the required degree of comparability required for RPM.”

(o) Further, the RPM evaluates the arm‘s length nature of a controlled transaction by reference to the gross profit margin realised in a comparable uncontrolled transaction. But it is difficult to get data required for computing gross margins of comparable companies.

(p) RPM requires Close comparability of Functions, Assets and Risks

The transaction of Import and resale of CBU and spares are different on the following grounds:

• Spares and cars (i.e. CBUs) cannot be even said as same or similar products. While the car is a fully finished product, which is ready to use by a consumer, spare parts are a small part of the car, carrying a fraction of the car’s value and to be used by a service provider (automobile service stations);
• The Assessee performs marketing functions only for sale of CBUs and not for sale of spares.
• The market for spares and CBUs is very different; and
• CBU imports are restricted to only those models that are not manufactured in India whereas all the spares dealt in by MB India are for manufactured as well as imported cars.

(q) The Assessee submits that there are various functions which are not performed for CBU activity but are performed for spares activity namely maintenance of huge godown space, sorting of spares according to types and at appropriate places, packing, repacking and dispatch activity of spares, daily processing of orders, compliances to Central Excise Act, its‘ detailed procedures and the Standards of Weight and Measures Act and recruitment of the staff and staff cost to handle the spares. The differences in the functions performed, assets employed by MB India for the CBU and spares segment are detailed at page 561 to 563 of Paper book.

(r) Thus, only because the products are imported and then resold to the third parties in India, the functions performed cannot be said to be same or similar.

The learned TPO has also disregarded the fact that for additional functions, assets and risks the seller would increase the price which results in higher gross profit, as the cost of such higher functions, assets and risks is below gross profit and hence increases the gross profit. The learned TPO‘s argument that cost for higher functions, assets and risks would impact net margin is correct, however, he grossly fails to appreciate that the revenue for higher functions, assets and risks would be reflected in the Sales. Further, the Assessee submits that Rule 10B(2) which describes the methodology for application of RPM, states that it is necessary that the transactions being compared should be uncontrolled and it should be identified taking into account the functions performed, risks undertaken and assets employed. The learned TPO has failed to demonstrate that any of the above criteria have been met while identifying a controlled transaction of the Appellant itself as comparable.

Differences in function, asset and risk profile of the Spares segment vis-à-vis CBU segment

The Assessee has relied on Rule 10B(1(b)(iv)) of the Rules to factor the differences affecting the margins of the taxpayer vis-à-vis comparable. There are significant differences in the functions, assets utilized and risks assumed by MB India in case of import and sale of CBUs and that of spares sales which are mentioned below:

Parameters	Import of spares	Import of CBUs
Functions performed	Higher	Lower
Risks undertaken	Higher	Lower
Assets employed	Higher	Lower
Space requirement and storage cost	Higher	Nil
Manpower	Higher	Lower
Transportation  and other related costs	Higher	Lower

These factors need to be taken into account before making any adjustment.

8. We find that Pune Tribunal in assessee‘s own case for A.Y. 2005-06 (supra) has observed and held as follows:

(a) Decision of Hon’ble ITAT with respect to the combined transactions / aggregation approach (page 52 and 53 of paper book):

“32. Now, coming to the facts of present case, where the assessee was engaged in the activities of manufacture of passenger cars worldwide many models of Mercedes Benz were available. However, in the year under consideration the assessee was engaged only in manufacturing activity of C and E class brands of passenger cars. But in order to make available other brands available worldwide, to its customers in India and in the absence of manufacturing facility developed for such models, the assessee imports CBUs and resells the same to customers. The assessee has placed on record some models which were imported in the year under consideration are being manufactured by the assessee in later years, since the demand for such models had increased. In order to efficiently run its business, the assessee had adopted a methodology, under which the most popular models were being manufactured in India and in order to widen its customer base at par the requirement of customers or otherwise, the assessee was importing other models from its associated enterprises. Such import of CBUs and its resale was closely and interlinked to its basic activity of manufacture of passenger cars. Hence, the same has to be aggregated with import of raw materials and cannot be benchmarked independently.

33. The third segment was import of spare parts which were being imported from associated enterprises in order to fulfil warranty commitments of passenger cars sold by assessee i.e. both manufactured and imported CBUs and also in order to meet other requirements of customers. Undoubtedly, warranty commitments were being fulfilled by dealers but under a dealership agreement, wherein the dealer was to use only spare parts which were made available by assessee. Such imports were being made of spare parts in order to keep the standard of products sold and also to maintain efficiency of passenger cars. The assessee had fairly admitted that it was covering cost of such spares, which were to be provided free of cost to customers under warranty commitments, from the cost of cars sold by it. In such scenario, the import of spare parts was an activity which was also closely connected with sale of manufactured and imported passenger cars and the same could not be benchmarked independently. Accordingly, we hold that transactions of import of CBUs and import of spare parts were closely and interlinked to the manufacture of passenger cars by assessee and the said activity was to be benchmarked on an aggregate basis along with other transactions under the umbrella of ^„manufacturing activity‘.

(b) Decision of Hon’ble ITAT with respect to comparison of controlled transaction with a controlled transaction and selection of RPM as the most appropriate method (page 57 of paper book):

“42. Following the above said principles, we hold that approach adopted by TPO in comparing margins of controlled transaction i.e. import of spare parts and import of CBUs from associated enterprises and proposing adjustment on account of arm’s length price of international transactions does not stand and the same is cancelled. Hence, the TPO had erred in applying RPM method. In any case, under the garb of RPM method, TPO has compared sale of spares with sale of passenger cars. Further, it may be pointed out that TPO compared margins of fully developed vehicles with margins of spare parts, but the two items cannot be said to be functionally comparable and hence, there is no merit in the stand of Assessing Officer / TPO in this regard.”

(c) The above decision has been followed by the Hon‘ble Tribunal in Appellant’s subsequent year‘s for AY 2006-07 to AY 2011-12 as below:

Assessment year	ITA No	Page reference of the paper book
AY 2006-07	(ITA 1468/PUN/2010)	12 to 16
AY 2007-08	(ITA 10/PUN/2012)
AY 2008-09	(ITA 298/PUN/2013)
AY 2009-10	(ITA 514/PUN/2014) (ITA 566/PUN/2014) (CO 24/PUN/2015)	1537 and 1539
AY 2010-11	(ITA No.380/PUN/2015) (ITA No.486/PUN/2015)
AY 2011-12	(ITA No. 546/PUN/2016) (ITA No. 534/PUN/2016)

9. We are in conformity with the view taken by the Tribunal in the aforestated lead case in regard to the assessee-company wherein it is held that the transactions of import of completely built unit (CBU) and import of spare parts were closely and inter-linked to the manufacture of passenger car by the assessee and the said activity is to be bench marked on an aggregate basis along with other transactions under the umbrella of ―manufacturing activity. The ld. D.R. also could not demonstrate or bring on record any facts or difference evidences and therefore, we are of the considered view, respectfully following the aforestated judgment on the same facts and circumstances and on same parity of reasoning, ground Nos. 3, 5, 6, 7 and 8 stand allowed.

10. Next set of grounds pertains to entity-widen manufacturing activity. In this regard, ground No. 9 is rejection of certain additional Indian companies and accepted certain inappropriate Indian companies as comparables. The brief backgrounds are that During the course of assessment proceedings, the learned TPO rejected all the comparable companies identified by the Appellant in its Transfer pricing documentation. The assessee upon the request of the learned TPO and on without prejudice basis submitted a fresh benchmarking analysis considering the Indian comparable companies (Indian car manufacturer) after eliminating companies having RPT more than 25%. The fresh benchmarking analysis using single year data i.e. FY 2011-12 was submitted vide submission dated 29 September 2015. Based on the search process, the following companies were identified as comparable to MB India.

Sr. No	Name of the company	Operating margin FY 2011-12
1	Force Motors Ltd	2.99%
2	Hindustan Motors Ltd	-22.03%
3	Premier Ltd – Automotive Segment	3.14%
	Arithmetic Mean	–5.30%

The arithmetic mean of comparable companies worked to -5.30% as against MB India‘s margin of 0.04% at entity level and accordingly, since the margins earned by MB India were higher than the arithmetic mean of the comparable companies, the transaction was concluded to be at arm‘s length price. However, the learned TPO rejected the Indian comparable companies (Force Motor Limited and Hindustan Motor Limited) identified by the assessee and considered Tata Motors and Mahindra and Mahindra as comparable by increasing the RPT filter from 25% to 30%.

11. The Hon‘ble DRP accepted the Force Motors Ltd as comparable company to MB India. However, for other comparables in dispute, Hon‘ble DRP upheld the order of TPO. The final set of comparables as per Hon‘ble DRP is tabulated below:

Sr. No	Name of the company	Operating margin FY 2011-12
1	Force Motors Ltd	2.99%
2	Premier Ltd – Automotive Segment	3.14%
3	Mahindra & Mahindra Ltd	9.19%
4	Tata Motors Ltd	4.83%
	Arithmetic Mean	5.24%

12. The assessee is now contesting the rejection of Hindustan Motors Ltd. (HML), and inclusion of Mahindra & Mahindra Ltd (M & M). Broadly, the assessee submits that HML i.e. Hindustan Motors Ltd. is functionally comparable to the assessee which has been duly accepted in A.Y. 2009-10 by the learned D.R.P. That 85% of the revenue earned by HML is from sale of vehicles. The assessee further contended that the reasons for incurring losses are routine business reasons and not extra ordinary in nature. The company is adding products to its portfolio and thus has an ongoing business. The rejection of HML by T.P.O is that it is consistent loss maker. However, it is submitted by the assessee that automobile industry itself is incurring loss. Hon‘ble Delhi High Court in the case of Nokia Siemens Network India P. Ltd. (ITA No. 692/2019) has held that incase the general trend in the nature is of either loss making or declining revenues, a functionally comparable company should not be rejected. In this case, HML was already accepted as comparable company by T.P.O and the learned D.R.P in A.Y. 2009-10. The assessee submitted that the concept for rejecting the comparables merely on account of incurring losses is neither defined nor mentioned in the Indian TP Regulations nor does it find any mention in the OECD guidelines. Another objection of the T.P.O has been that HML is into persistent loss and only revenue is from sale of assets. In this regard, it is submitted by the assessee that above observation by the T.P.O is factually incorrect. Since as per the P & L a/c it clearly indicates that the revenue from sale of vehicles as a percentage of total sales is 85.56%.

13. We find that from the annual report of the company and the other financial statements placed on record that HML has incurred losses only on account of normal operating business and not due to any extra ordinary circumstances. Here, learned D.R also could not bring any material on record to suggest occurrence of extra ordinary business which triggered to loss, if any. While rejecting HML T.P.O has failed to appreciate the fact that in every industry there are companies that make losses as well as there are companies which make profits. What is to be looked into whether the comparable functional is attributable with that of the assessee. In this case, HML has been functionally accepted both by the T.P.O and learned D.R.P as functionally comparable with the assessee in A.Y. 2009-10 and no one disputed that. More than 88% of the revenue is earned by HML from sale of vehicles. HML also launched new vehicle ―Pajeo-Sport‖ and seven-seater upgraded version of Mitsubhishi Outlander during the year as evident from the annual report. Further, in this regard, we find the Hon‘ble Delhi High court in the case of Nokia Siemens Network India P. Ltd. (ITA No. 692/2019) observed and held as follows:

“5. The ITAT differed from the view expressed by the TPO and accepted the reasoning put forth by counsel for the Assessee that the finances of the three comparables which included ITI Ltd., with reference to their respective annual reports, did show that there was a general trend in the industry of either loss-making or declining revenues. The ITAT was of the view that loss making companies should not be excluded only on that basis. In the present case, there was no dispute on the functional profile of the assessee being similar to that of ITI Ltd. In support of its conclusion, the ITAT referred to the decision of this court in Chryscapital Investment Advisros (India) (P) Ltd. Vs. Dy. CIT (2015) 376 SITR 183 (Del).

6. Having heard the learned counsel for the parties, the Court is of the view that the opinion expressed by the ITAT is a plausible one in the facts and circumstances of the case. The inclusion of ITI Ltd. and the other two comparables is supported by sound reasoning given by the ITAT which in the considered view of this Court cannot be said to be perverse. No substantial question of law arises.”

14. We are of the considered view as noted by the Hon‘ble Delhi High Court in Nokia Siemens Network India P. Ltd. (supra) that a comparable cannot be rejected merely on the ground that it is recurring losses if the industry in which the comparable operating itself is incurring loss. Following this view, we direct the A.O/T.P.O to include HML as comparable in respect to the assessee company.

15. The assessee also wants exclusion of Mahindra & Mahindra Ltd (M&M) from the final list of comparables. In this regard, the assessee, during the T.P proceedings submitted benchmarking analyses considering the Indian comparable companies (Indian car manufacturer) after eliminating companies having RPT more than 25%. The assessee rejected M&M on the basis of RPT filter, as the related party transactions exceeded the 25% criteria. However, the T.P.O considered M&M as comparable by relaxing the related party transaction filter from 25% to 30%.That on similar ground, the assessee also wants exclusion of Tata Motors Limited (TML) since in T.P. study report, the assessee has eliminated companies for having RPT more than 25%. The assessee rejected TML on the basis of RPT filter, as the related party transactions exceeded the 25% criteria. However, the T.P.O considered TML as comparable since aggregated of cost and revenue side transactions on a stand-alone basis are less than 30% as applied by the T.P.O. In this regard, the assessee submitted that in respect of the related party transactions (RPT) filter of 15% should be applied. The assessee places reliance in the decision of the Pune Tribunal in the case of Skoda Auto India Pvt. Ltd. (ACIT (ITA No. 154/PUN/2011 and C.O No. 34/PUN/2011), for the A.Y. 2004-05, order dated 10^th June 2019 and the decision of Co­ordinate Bench Bangalore in the case of Toyota Kirloskar Auto Parts Pvt. Ltd. Vs. DCIT in ITA No. 1714/Bang/2016 and ITA No. 1364/Bang/2017 for A.Y. 2012-13, order dated 10-2-2022. The assessee before us further submitted that in its transfer pricing documentation for each of the earlier years, the assessee has consistently applied the policy eliminating companies having related party filter of more than 25% and the same has been accepted by the T.P.O for each of the previous year. We find that in the case referred before us of the Pune Tribunal in Skoda Auto India Ltd. (supra) the Bench held as follows:

“11…..The Revenue is aggrieved and has pointed out that the RPT filter which is applied was less than 25% of the total transaction and hence, three concerns originally selected by the Transfer Pricing Officer should be included for benchmarking the international transaction between the assessee and its Associated Enterprise. The assessee in the present case while benchmarking the international transaction undertaken, had excluded three concerns Honda Siel, Hyundai Motors and Maruti Udyog on the ground of RPT filter of 15%, though they were functionally similar to the assessee. The assessee‟s objection to the same was that the margins of the said concerns could not be applied because they do not fulfil the RPT filter. In several cases, the Tribunal had held that while benchmarking the international transaction between the assessee and its Associated Enterprise and comparing the margins with margins of concerns, then one of the filters to be applied is RPT filter.

……………

13. Applying the said filter of RPT, the benchmarking has to be carried out. In the facts of the present case before us, the Assessing Officer did not apply any RPT filter but the CIT(A) had applied RPT filter of 15% and the three concerns were excluded in the hands of the assessee. In view thereof, we find no merit in the issue raised by the Revenue vide ground of appeal No.1. We hold that the RPT filter needs to be applied in the present set of facts and the three concerns having not fulfilled RPT filter cannot be included in the final list of comparables. In the case of assessee itself, the Assessing Officer / TPO had applied RPT filter of 25% in assessment year 2005-06. Hence, there is no merit in plea of Revenue. Ground of appeal No.1 by the Revenue is dismissed.”

16. We further find that the Bangalore Bench in Toyota Kirloskar Auto Parts Pvt. Ltd. (supra) has held as follows:

“7.1 Further, the TPO has applied RPT filter of 5% (para 7 at page 8 of the TPO‟s order), the application of filter at 5% has no basis and has no legal sanction. Various orders of the Bangalore Tribunal had held that RPT filter of 15% should be adopted. Hence, fresh TP analysis should be conducted by applying RPT filter at 15%.”

17. We are therefore of the considered view that in any case what has been consistently held by the Tribunal and we are also in conformity that RPT filter of 15% should be adopted. In both the cases of comparables selected by the T.P.O., M&M have RPT from 25% to 30% and in case of TML the aggregate cost or revenue side transaction on a standalone basis are less than 30% as applied by the T.P.O. Therefore, in both these cases, the RPT filter is more than 15%. Accordingly, we direct the A.O/T.P.O to exclude the companies M &M and TML from the final set of comparables with respect to the assessee company.

18. Ground No. 10 is regarding computation of operating margin of the assessee at entity level without taking into consideration the excess custom duty paid on imports by assessee vis-à-vis comparable companies. During the year, the assessee has imported raw material, CBUs and spare parts from its associated enterprise. The import content of MB India was 72.49%. This higher import content of the Company as compared to comparable companies (selected by the learned TPO) resulted in higher incidence of custom duty when compared to its comparable companies. So due to higher percentage of imports by the Company than that of comparable companies, it is required to bear these additional cost/charges as compared to comparable companies which are having low percentage of imports. From the table below, it can be observed that the Company has significantly higher percentage of imports as compared to its comparable companies.

S. No.	Name of the company	Imported raw material, components and spares (In Crores)	Total purchase (In Crores)	Percentage
1	Tata Motors Ltd	1,635.39	33,894.82	4.82%
2	Mahindra & Mahindra Ltd	656.09	18,804.52	3.49%
3	Premier Ltd-Automotive Segment	32.18	163.28	19.71%
4	Force Motors Ltd.	332.57	1,492.98	22.28%
	Average			12.57%
	MB India	1146.49	1581.55	72.49%

(a) From the above, it can be observed that the Company has significantly higher percentage of imports 72.49% vis-a-vis the comparable companies (12.57%). Hence, the additional cost incurred by the Appellant as compared to the comparable companies on account of custom duty would have to be neutralized so as to facilitate the profit comparison with the comparable companies. However, the learned TPO did not take into consideration the excess custom duty paid by MB India on imports while computing the operating margin of MB India.

(b) The assessee would like to mention that the assessee has considered non-cenvatable custom duty for the purpose of import duty adjustment. These details are not available in case of comparable companies. The assessee needs to derive the normalized operating profit which can be compared with the comparable companies. Accordingly, the assessee used the details available in the public domain, i.e., the percentage of imports to total purchases of comparable companies and compared the same with its own percentage and basis the same has given the effect of excess import cost for non-cenvatable customs duty on its own margins.

(d) In this regard, the assessee places reliance on the following judicial precedents:

Jurisdictional Pune Tribunal‘s in case of Demag Cranes & Components (India) Pvt Limited vs DCIT [ITA No 328/PN/2014], wherein the adjustment on account of expenses related to import of raw material has been granted on the tested party. The relevant extract of the judgment is given below.

“The issue relating to grant of adjustment on account of import cost of raw materials, spares and cost was raised by the assessee in appeal before the Tribunal in assessment year 2006-07 in ITA No. 120/PN/2011 decided on 04-01­2012. The Tribunal remitted the issue back to the file of TPO with direction to examine the claim of assessee relating to import cost factor and eliminate the difference, if any. The relevant extract of the findings of Tribunal are reproduce here-in-below :

“….37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). It is relevant mentioned that we have already analysed the relevant provisions of Income Tax rules vis-à-vis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of ^„working capital.‟ In principle, our findings on the issue remain applicable to the adjustments on account of import cost mentioned in ground 4(b) too….One such decision relied upon by the Assessse‟s counsel supports our finding relates to the decision of this bench of the Tribunal in the case of Skoda Auto India P ltd 122 TTJ 699 (Pune) dated March 2009.”

Jurisdictional Pune Tribunal in case of Skoda Auto India Pvt Ltd Vs ACIT 30 SOT 319, wherein the ITAT states as follows (the decision enclosed as Attachment 6 to this fact sheet):

“19…The other way of looking at the present situation is to accept that business models of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments thus are required either way. It is therefore permissible in principle to make adjustments in the costs and profits in fit case”

(e) Quantification of Excess import duty cost incurred by MB India

Computation of excess import duty cost considering the comparable companies selected by the TPO

4Sr No	Ref	Name of company	Amount (Rs.)
1	1	Tata Motors Ltd	4.82%
2	2	Premier Ltd-Automotive Segment	19.71%
3	3	Mahindra & Mahindra Ltd	3.49%
4	4	Force Motors Ltd	22.28%
		Average	12.57%
		Computation of import duty adjustment
	A	Total value of raw material imported & indigenous for MB India for FY 2011-12	15,81,55,36,285
	B	Total value of raw material imported for MB India for FY 2011-12	11,46,49,34,675
	C=B/A	Import percentage of MB India	72.49%
	D	Total non cenvatable duty paid by MB India	1,34,13,43,074
	E	Average import content of comparable companies	12.57%
	F=D/C*E	Duty that would have been payable as per industry standards	23,26,58,696
	G	Excess of non cenvatable duty paid by MB India due to high imports	1,10,86,84,378

Calculation of operating margin of MB India at entity level after factoring the excess custom duty paid as computed above

Particulars	Ref	Amount (Rs/Lakhs)	Amount (Rs/Lakhs)
Total operating revenue	A		2,36,521.01
Total operating expenses	B		2,36,421.60
Operating Profit	C=A-B		99.41
Operating Profit (%)	D=C/A		0.04%
Add: Adjustments
– Extra duty on account of higher imports		11,086.84
Total	E	11,086.84	11,086.84
Adjusted Operating Profit	G=C+E		11,186.25
Adjusted Operating Profit Margin	H=G/A		4.73%

19. The assessee before us placed reliance on judicial decisions of Demag Cranes & Companies (India) Pvt. Ltd. Vs. DCIT (ITA No. 328/PN/2014) and Skoda Auto India Pvt. Ltd. Vs. ACIT in SITA No. 202(Pune) of 2007 for A.Y. 2003-04 dated 12-3-2009 and prayed that the issue may be remanded back to the file of the A.O/T.P.O for re-computation of the operating margin of assessee after taking into consideration the excess custom duty paid on imports as non-operating in nature. The ld. D.R did not raise any objection in this regard. In view of the matter, this issue is restored to the file of the A.O/T.P.O to conduct the aforesaid exercise while complying with the principles of natural justice.

20. Ground No. 11 is reading computation of operating margin of the assessee at entity level, without excluding additional cost on account of abnormal foreign exchange rate movement. During the year, the assessee has imported raw material, CBUs and spare parts from its associated enterprise. The import content of MB India was 72.49%. This higher import content of the Company as compared to comparable companies (selected by the learned TPO) resulted in increased cost of purchases when compared to its comparable companies. So due to higher percentage of imports by the Company than that of comparable companies, it is required to bear additional cost (due to foreign exchange rate fluctuation) as compared to comparable companies which are having low percentage of imports.

(a) The assessee submits that, during the year under consideration, MB India was significantly impacted by the adverse fluctuation in the foreign exchange currency and its net profit margin has also been adversely affected. Further, a significant portion of the cost includes the cost of goods purchased by MB India in the form of import from its AE.

(b) Further, the assessee submits that the average sale realisation price per unit has gone down to Rs 0.24 crores (approx.) from Rs 0.29 crores (approx.) for the year under consideration. As against the same, the cost of raw material has increased significantly which has resulted in higher consumption of raw material to sales ratio compared to earlier year. The primary reason for such significant increase in raw material cost is abnormal variation in the exchange rates. Accordingly, in order to eliminate the impact of such fluctuations, the assessee requested to grant adjustment pertaining to foreign exchange rate fluctuation. In this regard, the assessee submits as follows:

(c) Impact of fluctuations in Exchange Rate on MB India‟s Margins:

With respect to above, MB India has quantified such impact by collating data for the INR v/s EUR exchange rates for the period under consideration (i.e. AY 2012-13) vis-à-vis the previous year (i.e. AY 2011-12) which is enclosed in the paper book on page 848-849 including the back- up documents for the exchange rates. The summary of exchange rate fluctuation during the AY 2012-13 vis-à-vis AY 2011-12 is tabulated below for your Honour‘s easy reference:

Sr.No	Month	AY 2012-13	AY 2011-12
		Exchange Rate	Exchange Rate
1	April	65.82	58.96
2	May	64.76	57.17
3	June	64.80	56.95
4	July	63.04	60.74
5	August	66.71	59.52
6	September	66.69	61.03
Sr.No	Month	AY 2012-13	AY 2011-12
		Exchange Rate	Exchange Rate
7	October	68.38	61.81
8	November	69.45	60.37
9	December	68.96	59.85
10	Jan	65.52	62.55
11	Feb	65.95	62.17
12	March	68.36	63.24
	Average	66.54	60.36
	Percentage increase in EUR vis-à- vis INR in the current year over previous year	10.23%

(d) Accordingly, as per the computation enclosed on page 848 of the paper book, it is evident that the year under consideration witnessed around 10.23% increase in the Euro/ INR rate vis-à-vis previous year. The impact of the movement in exchange rate on the profitability of MB India would be by two types:

• The cost of imported raw material, spares, CBUs, etc. would significantly go up which would be reflected by way of increased cost of raw material, spares, CBUs, (‘Impact 1‘); and
• Exchange loss debited in the books of account for difference in exchange rate while booking the invoice and actual payment of the same (‘Impact 2‘).

(e) In order to factor in the loss on account of exchange rate movement Impact 2, MB India treated the foreign exchange loss amounting to Rs 14.60 crores debited to the profit and loss account as non-operating expenses while computing its operating margin at entity level for AY 2012-13 at 0.04% and this part was accepted by the learned TPO.

(f) Further, keeping all other factors constant, in order to factor in the Impact 1 of exchange rate fluctuations, MB India‘s profitability is computed. While computing the profitability, the assessee has considered the adjustment on account of foreign exchange fluctuation (net of Impact 2 mentioned at para (d) above already considered.

Based on the above-mentioned working, the operating margin of MB India works out at 4.35% keeping all the factors constant.

Further, the assessee places reliance on Demag Cranes & Components (India) Private Limited Vs DCIT, (ITA No 328/PN/2014) wherein the Pune Tribunal has upheld such an adjustment by observing as under:

“16. In ground No. 8 the assessee has assailed the findings of TPO and DRP in not granting abnormal exchange rate appreciation adjustment. The ld. AR of the assessee has contended that there has been substantial fall in the value of INR vis-à-vis EURO. Since, the assessee is using significant volume of imported inputs viz. raw materials, spares, consumables. The assessee has given chart giving month wise exchange rate fluctuation of EURO vis-à-vis INR in financial year 2008-09 and financial year 2007-08. The same is reproduced here-in-below:

Period	Exchange Rate INR per EURO
	F.Y. 2008-09	F.Y. 2007-08
April	63.09	57.07
May	65.39	55.27
June	66.69	54.77
July	67.65	55.45
August	64.49	55.60
September	65.67	56.07
October	66.89	56.28
November	63.69	57.89
December	66.88	57.49
January	66.42	57.88
February	63.65	58.47
March	67.91	62.45
Average	65.70	57.06

(g) A close look of the chart show that in financial year 2007-08 average EURO rate was `57.06, whereas the average rate of EURO in financial year 2008-09 increased to `65.70. Thus, there was increase of about 15% in the value of EURO as against INR. In transfer pricing, adjustment has to be made for any abnormal change in the exchange rate fluctuation. Abnormal fluctuation in exchange rate has impact on the cost of inputs which are imported. The Delhi Bench of the Tribunal in the case of Honda Trading Corporation India Private Limited Vs. ACIT (supra) has granted exchange rate fluctuation adjustment where the value of INR has substantially fallen as compared to foreign currency of trade. The relevant extract of the findings of Tribunal are reproduced here-in-below:

“19…………………………. On the issue of adjustment of exchange fluctuation, loss incurred by the assessee, we observe that it is a well accepted principle of Transfer Pricing regulations to compare like with like and eliminate the differences if any, by suitable adjustment. The said principle clearly provides for adjustments in margins of the enterprise entering into international transactions for any differences between such international transactions and the transaction of comparables or between the enterprise entering into internationals transactions and comparable companies. The foreign exchange element also needs consideration. Rule 10B(3) of Income Tax Rules, 1962 provides that an appropriate adjustment is required to be made on account of the differences between the controlled and the uncontrolled transactions. This rule clearly stipulates that an uncontrolled transaction shall be comparable to an international transaction, if none of the differences between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market. This rule clearly stipulates that reasonably accurate adjustments can be made to eliminate the material effects of such differences.

20. xxxxxxxxxx

21. xxxxxxxxxx

22. In the case in hand, admittedly, the average exchange rate of Thai Bhat during October, 2005 to March 2006 was 100 Thai Bhat equivalent to INR 110 and after consideration of said average exchange rate, price of sale of goods had to be agreed upon with the customers. The DR has not disputed the point that during April 2006 to September 2006 at the time of purchase, the exchange rate of Thai Bhat was substantially increased and the average exchange rate of Thai Bhatt was increased to 100 Thai Bhat = INR 119. Accordingly, we cannot rule out and ignore this factual matrix emerged from the fluctuation of foreign exchange rates that while prices of purchases and import made by the appellant have increased, the sale price of exported goods remained on the lower side which is an important element to materially affect the price in the open market. In this situation, we are inclined to hold that the authorities below should have considered the said difference due to foreign exchange rate fluctuation in favour of Thai Bhat and against the INR and the said difference has to be removed and the margin thereon has to be adjusted for arriving at the credible comparable through the requisite adjustments.”

17. The ld. DR has not been able to controvert the submissions made on behalf of the assessee in respect of fluctuation in exchange rate. Thus, in view of the facts of the case, we are of the considered opinion that this issue needs a revisit to the file of TPO for grant of exchange rate fluctuation. The TPO after examine the documents on record and the exchange rate prevalent at the time of international transaction carried out by the assessee shall decide this issue de-novo. Accordingly, ground No. 8 raised in the appeal by the assessee is allowed for statistical purpose.

(h) Further, the Honourable Tribunal in assessee‘s own case for AY 2009-10 (ITA 514/PUN/2014), (ITA 566/PUN/2014), (CO 24/PUN/2015) the Hon‘ble Tribunal respectively observed that:

“28. The case of assessee before us is that the year under consideration witnessed around 14.10% increase in Euro / INR rates vis-à-vis previous year and hence, was an exceptional year, wherein profitability of assessee was impacted by adverse fluctuation in foreign exchange currency. The learned Authorized Representative for the assessee pointed out that similar issue arose before Pune Bench of Tribunal in Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT in ITA No.328/PN/2014, relating to assessment year 2009-10, order dated 19.10.2016 and it was held that where Euro rates had fallen, then it was an unique event for this year and such foreign exchange loss was to be excluded while computing PLI of assessee. We find merit in the claim of assessee in treating foreign exchange loss as non-operating in nature. There was fluctuation in the rate of Euro / INR rates when compared to the previous year and the market witnessed around 14.10% increase in Euro / INR rates. In such facts and circumstances, where the phenomenon was unique, then the same is to be excluded while computing PLI of assessee.

29. We find that same ratio has been laid down by the Tribunal in Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT (supra). The year under appeal in the case of Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT (supra) and the assessee is same. Following the same parity of reasoning, we direct the exclusion of foreign exchange loss while computing PLI of assessee company. Upholding the order of DRP, we dismiss the ground of appeal No.2 raised by Revenue.”

(i) Based on the above, MB India requests to grant adjustment on account of abnormal variation in the foreign exchange rate which resulted in significant increase in cost of raw material, spares, CBUs, etc. The working for the abnormal foreign exchange movement in current year vis-à-vis compared to previous year is reproduced below.

Sr. No	Reference	Particulars	Entity level
			Amount in lakhs
1	(A)	Total cost of goods imported during the year	1,25,646.67
2	(B)	Percentage increase in EUR in the current year over previous year	10.23%
3	(C) = A*B	Increase in the Cost of goods imported because of exchange rate fluctuations	11,659.25
4	(D)	Less: Foreign exchange loss already excluded from total expenditure in the TP report	(1,460.00)
5	(E)= C+D	Net increase in cost of goods imported because of exchange rate fluctuations	10,199.25
Impact on the margins of MB India’s
6	(F)	Operating Income as per Split profitability	2,36,521.01
7	(G)	Operating Cost as per Split profitability	2,36,421.60
8	(H) = (E)	Less: Net increase in cost of goods imported because of exchange rate fluctuation	(10,199.25)
9	(I) = G+H	Operating cost excluding increase in cost of goods imported due to exchange rate fluctuation	2,26,222.35
10	(J) = F-I	Operating Profit	10,298.66
11	(K)= J/F%	Operating Profit Margin	4.35%

(j) For this also, the assessee prays that the issue may be remitted back to the file of the A.O/T.P.O and he may be directed to re-compute the operating margin of MB (India) after making appropriate adjustment for abnormal movement in exchange rate treating it as non-operating in nature. The ld. D.R did not raise any objection.

21. We are of the considered view that the matter may be restored to the file of the A.O/T.P.O for re-adjudication as per aforesaid prayer made by the assessee while applying with the principles of natural justice.

22. Ground No. 12 is regarding computation of operating margin of the assessee at entity level without excluding extra-ordinary expenses on account of excess demurrage/detention charges and litigation claim.

(a) The assessee wishes to submit that, during the year under consideration, MB India witnessed a recession and slowdown in the Indian automobile industry, which impacted the luxury car segment significantly. Due to which MB India could not sell the vehicles as per operational plan. However, MB India has already placed orders for purchase of raw materials. Since there was significant build-up of raw materials inventory and because of storage constraints, the said inventory could not be cleared from the customs on timely basis.

(b) On account of which significant demurrage and detention costs was incurred by MB India, which was extra-ordinary in nature vis-à-vis compared to previous years. Accordingly, Appellant has claimed that higher demurrage/detention charges incurred by the Appellant should be factored in computing the operating margin of the Appellant.

(c) The details for the abnormal demurrage amounting to INR 17,60,54,902 are as below,

Financial year	Amount (Rs/
2008-09	28,469,233
2009-10	7,977,511
2010-11	27,296,741
Total	63,743,485
Calculation of Adjustment for current year
2011-12	197,302,730
Average for last three years	21,247,828
Adjustment for extra ordinary cost	176,054,902

(d) The learned TPO in the TP order with respect to demurrage/detention charges stated as follows:

Cleared from customs on a timely basis. In this regard, the comparable companies also operate in the same industry, and they may also be impacted in the same way as the assessee. Hence, this expense cannot be allowed as extra-ordinary expenses.

(e) With respect to above, the assessee submits that the import content of the comparable companies as selected by the learned TPO (on an average 34%) is significantly lower than the import content of MB India (72.49%) and accordingly it would be incorrect to say that the comparable companies may also have been impacted in the same way as assessee.

Litigation expenses

(f) The assessee wishes to submit that, during the year under consideration, MB India did an out of court settlement with some of the dealers who have filed suit against MB India. The dealers agreed the compensation and amount was paid in order to end the litigation. Accordingly, the assessee excluded the said expenditure for computing the operating margin of MB India considering the said expenses as one time extra ordinary cost.

(g) The details for the extra-ordinary litigation expenses are as below:

Particulars	Amount (Rs)
Expenses incurred by MB India
Payment of settlement amount to Millennium Motors	117,000,000
Litigation costs towards travel expenses	1,296,811
	118,296,811
Less: Provision for claim created during FY 2010-11	(71,994,081)
Extra-ordinary amount towards litigation debited to Profit and loss a/c during FY 2011-12	46,302,730

(h) The ld. TPO in the TP order with respect to litigation expenses stated as follows:

(i) And it was a one-time extra ordinary expense. In this regard, the litigation settlement was made by the assessee purely on account of business reasons, so that the litigation costs can be reduced. Hence, the litigation claim cannot be allowed as extra ordinary in nature.

(j) With respect to above, the assessee submits that inadvertently dealership of one of the dealer was discontinued without prior intimation to the dealer as per the terms agreed and accordingly the dealer filed case against MB India for which out of court settlement was done. MB India submits that this was one–off scenario and accordingly said cost incurred by MB India is extra­ordinary in nature.

23. The assessee prayed that the learned A.O/T.P.O be directed to re-compute operating margin of the assessee after making appropriate adjustment for extra ordinary cost of demurrage/detention charges and litigation expenses treating it as non-operating expenditure. The ld. D.R did not raise any objection if this issue is remitted to the file of the A.O/T.P.O. In view thereof, we remand this issue to the file of the A.O/T.P.O as per the aforesaid prayer made by the assessee and re-adjudicate as per law applying with the principles of natural justice.

24. Ground No. 13 deals with transfer pricing adjustment to be limited to the international transaction with AEs only. The assessee submits that the T.P.O and consequently the A.O have computed the ALP of the international transaction of the assessee at entity level under the TNMM based on the total operating income of the assessee. However, without prejudice to any other ground of objections by the assessee, the assessee contends that the transfer pricing adjustment of Rs. 56.52 crores if any has to be made to the total income of the assessee and it should be in proportion of the international transactions of the assessee with its AEs only and not with reference to the total operating income of the assessee. In this regard, the assessee places reliance in the decision of Hon‘ble Jurisdictional High Court in the case of PCIT vs. Sandvik Asia Pvt. Ltd. (ITA No. 1088 of 2015), dated 26-4-2018 wherein it was observed and held by the Hon‘ble Jurisdictional High Court as under:

“3 Re. Question (a):­

(i) It is an agreed position between the parties that the issue raised herein stands concluded against the Revenue by the following decisions of this Court:

(i) CIT v/s. M/s. Ratilal Becharlal & Sons (Income Tax AppealNo.1906 of 2013) rendered on 24th November, 2015;

(ii) CIT v/s. Goldstar Jewellery Design (P) Ltd., (Income Tax Appeal No.2237 of 2013) rendered on 4th February, 2016 ;

(iii) CIT v/s. Alstom Projects India Ltd., (Income Tax Appeal No.362 of 2014) rendered on 14th September, 2016; and

(iv) CIT v/s. M/s. Bhansali & Co., (Income Tax Appeal No.1066 of 2014) rendered on 9th December, 2016.

(ii) Besides the aforesaid decisions of this Court, the issue also stands covered by the decision of the Delhi High Court in CIT v/s. Keihin Panalfa Ltd., (Income Tax Appeal No.11 of 2015) rendered on 9th September, 2015.

(iii) In all the aforesaid decisions, it has been held that the Transfer Pricing Adjustment is not to be done at the entity level but only in respect of international transactions of the Respondent with its Associated Enterprise (AE). This, on the application of proportionate method.

(iv) In the above view, question as proposed does not give rise to any substantial question of law. Thus, not entertained.”

(a) The assessee further submits that Learned TPO has followed the above principle while computing the adjustment for CBU segment and restricted the adjustment to international transaction in the Assesse‘s own case for the year consideration. Accordingly, assessee prays that the same methodology may be followed by the A.O./T.P.O in this regard also. In view of the aforesaid judgment of the Hon‘ble Jurisdictional High Court and the submissions of the assessee and as conceded by the learned D.R this issue is remanded back to the file of the A.O/T.P.O to adjudicate as per law and according to the principles enshrined in the aforesaid judgment while applying the principles of natural justice.

25. Ground No. 14 is with regard to inappropriate use of single year data. Referring to this ground of appeal, the assessee has filed letter dated 12-7-2022 stating as under:

ITA No. 495/PUN/2017 for A.Y. 2012-13
Sub: Grounds not pressed by the appellant

In relation to the aforementioned appeal filed by the appellant, on behalf of and under the instructions from the appellant and as mentioned during the course of the hearing dt. 24-6-2022, the appellant wishes to submit as follows;

The appellant wishes to not press the below grounds of appeal that were filed before your Hon‘ble Bench;

Ground 14: Inappropriate use of single-year data

Erred on the facts and circumstances of the case and in law by not considering multiple year data for determining the arm‘s length price.”

26. In view of the above, ground No. 14 is dismissed as not pressed.

27. Ground No. 15 relates to the transfer pricing adjustment without giving benefit of +/- percent as available under the proviso of sec. 92C(2) of the Act. In this regard, the assessee places reliance in its own case for A.Y. 2005-06 (ITA No. 1083/PUN/2013 and ITA No. 1110/PUN/2013 and C.O. No. 60.PUN/2014 wherein at page 36 the Tribunal held as follows:

“The ground appeal No. 8 raised by the assessee is against allowing +/-5% range, which is directed to be allowed.”

28. In view of the aforesaid judgment in assessee‘s own case for A.Y. 2005-06 ground No. 15 raised by the assessee stands allowed. 27. Ground No. 16 is with regard to the disallowance of royalty expenditure. The assessee submits that it is a Company incorporated under the provisions of the Companies Act, 1956, and is engaged in the manufacture and sale of Mercedes-Benz passenger cars in the Indian Pursuant to a ‗Technology License Agreement‘ entered by the Appellant with Daimler AG, it had paid an amount of Rs 12,51,11,877 as royalty to Daimler AG during FY 2012-13. The key terms of the agreement, as amended from time to time provide the following:

• Grant to MB India a non-exclusive license within India to assemble, manufacture and sell licensed vehicles and engines (‘licensed products‘) including pertinent parts and components;
• Non-exclusive right to MB India to export such licensed products;
• Supply by Daimler AG to MB India of drawings and designs and full technical product documentation required for the manufacture of licensed products;
• Continuous support by Daimler AG to MB India of all technical information relating to improvements and developments in the manufacturing process of the licensed products;
• Right to use of the name and trademarks of Daimler AG during the currency of the agreement; and
• Providing training to MB India‘s personnel at Daimler AG premises.

(a) In consideration of the above, as per Article 13 of the agreement, MB India is required to pay to Daimler AG, an annual royalty at 5% of the value addition on licensed vehicles sold after 1 January 1999. The agreement gets amended from time to time to amend/extend the scope by adding or deleting vehicles models. The terms of the agreement were further amended with effect from 1 October 2007 based on the perusal of various clauses of the agreement as summarized above, it can be seen that:

MB India has not acquired know-how from Daimler AG on an outright basis. MB India has only acquired a license/right to use know-how of Daimler AG in respect of the licensed products.

The agreement clearly provides that Daimler AG will remain the sole and exclusive owner of the technical know-how, technical information, trade mark etc. and that MB India is debarred from claiming any title to the said rights. Such license right cannot be equated with ownership rights.

The right of MB India to manufacture and sell licensed products in India does not restrict the rights of Daimler AG to sell the Licensed Products in India.

No copyright has been transferred to MB India. In fact the agreement states that copyright of the technical product documentation, including any modifications as well as the know-how and any patents contained therein would remain the property of Daimler AG.

There are restrictions placed on MB India from divulging confidential information obtained under the agreement to any third party.

Upon the termination of the agreement, MB India is required to immediately discontinue all assembling/ manufacturing and sales operations of the licensed products

(c)  From the above terms and conditions, it is clear that MB India’s rights under the agreement ends on termination of the agreement. It also evident that MB India has neither acquired any assets on an outright basis nor secured any enduring advantage. The benefit secured by MB India is essentially a license right to use the know-how for the period of the agreement and the royalty expenditure in this regard is therefore revenue in nature.

(e) In relation to AY 2012-13, as mentioned above, the Ld. AO relying on the orders passed by the erstwhile AO‘s during the assessment proceedings for AY 2004-05 to AY 2011-12 and further relying on the Hon‘ble DRP‘s directions pertaining to AY 2007-08 to AY 2011-12 disallowed the royalty expenses by considering it to be a capital expenditure in its Draft Assessment order. The said ground was further raised before the Hon‘ble DRP, however the DRP by considering it to be an issue similar previous year upheld the disallowance made by the Ld. AO.

(f) Further, the assessee submitted that the facts of the ground have already been considered in A.Y. 2002-03 to A.Y. 2013-14 and A.Y. 2014-15. In respect of the said issue in A.Y. 2002-03 the co-ordinate Bench Pune held that the royalty paid MB India is revenue expenditure. The relevant observation of Pune Bench Tribunal is as follows:

“ We find no infirmity in the above decision of the Ld.CIT(A). From the various terms and conditions of the agreement, we find the Assessee has neither acquired any asset on an outright basis nor secured any enduring advantage. We find force in the argument of Ld. Counsel for the Assessee that the benefit secured by the Assessee is essentially a licensed right to use knowhow for the period of the agreement. Therefore, the royalty expenditure in this regard, in our opinion, is revenue in nature.”

29. The assessee further submits that the status on account of royalty for various years is provided as follows:

Assessment Year	Status	Date of the order	Status of the Issue
AY 2000-01 and AY 2001- 02	– Allowed as revenue expenditure by the Hon‘ble CIT(A) and also confirmed by the Hon‘ble ITAT for AY 2000-01 and AY 2001-02	23 December 2021	In Favour of MB India
AY 2002-03	-Allowed as revenue expenditure by the Hon‘ble ITAT for AY 2002-03	06 June 2016 (Refer page 131 to 192 of the Paper Book)	Department Appeal pending before Hon‘ble Bombay High Court for admission of appeal
AY 2003-04 and AY 2004-05	-Allowed as revenue expenditure by the Hon‘ble ITAT for AY 2003-04 and AY 2004-05	30 Sept 2016 (Refer page 88 to 130 of the Paper Book)
AY 2005-06	-Allowed as revenue expenditure by the Hon‘ble ITAT for AY 2005- 06	25 October 2018 (Refer page 23 to 65 of the Paper Book)	Department Appeal pending before Hon‘ble Bombay High Court for admission of appeal
AY 2006-07, AY 2007-08 and AY 2008-09	-Allowed as revenue expenditure by the Hon‘ble ITAT for AY 2006- 07, AY 2007-08 & AY 2008-09	30 April 2019 (Refer Page 1 to page 22 of the Paper Book)
AY 2009-10, AY 2010-11 and AY 2011-12	-Allowed as revenue expenditure by the Hon‘ble ITAT for AY 2009-10, AY 2010-11 and AY 2011-12.	31 July 2019 (Refer page 1540 of the Legal Paperbook)
AY 2013-14	Hon‘ble DRP upheld AO‘s order considering royalty expenditure to be capital in nature	Not Applicable	Pending before Hon‘ble ITAT
AY 2014-15	Expenditure allowed by the Hon‘ble CIT(A) as revenue deduction	Not Applicable
AY 2015-16 AY 2016-17 and AY 2017-18	Disallowed by the Hon‘ble AO based on the decisions in previous years	–	Pending before Hon‘ble CIT(A)
AY 2018-19	Disallowance made by the DRP in the DRP directions. Final order pending to be issued	Final order is yet to be issued	Appellant to file an appeal once final order is issued

(g) Respectfully following the aforesaid decision of Pune Tribunal in assessee‘s own case on the same parity of reasoning, facts and circumstances, we hold that the royalty expenditure in this regard is revenue in nature. Accordingly the Ground No. 16 stands allowed.

Ground No. 17 is with regard to disallowance of Homologation expenditure. The learned A.O disallowed the expenditure incurred on homologation amounting to Rs. 2,34,85,773/- by considering it to be a capital expenditure. During the assessment proceedings the assessee was asked to explain the nature of expenses in response to which the assessee submitted the details of the expenditure and also provided reasons as to why the said expenditure should be considered as a revenue expense. The assessee further submits that on this issue for A.Y. 2009-10, 2010-11 and 2011-12 in assessee‘s own case the Pune Tribunal has held this expenses to be a revenue expenditure. In ITA No. 546/PUBN/2016 and others dated 31-7-2019 on this issue Pune Tribunal held as follows;

23. We have heard the rival contentions and perused the record. In the line of business of assessee i.e. manufacture and sale of passenger cars, the automobiles which were manufactured were governed by Central Motor Vehicles Act (CMV Act) and Central Motor Vehicle Rules (CMV Rules). Under the said regulations, it is mandatory to seek approval from the agency of the Government before making any technical changes in the existing model and also before introducing new vehicle / any upgraded version of existing vehicle before its commercial use. The ARAI makes the certification in this regard. Rules 91 to 126A of CMV Rules regulate the construction, equipment and maintenance of motor vehicles. The requirement of Rule 126 is that every manufacturer or importer of motor vehicles shall submit Prototype of vehicles, to be manufactured or imported by him, for testing by the Vehicle Research and Development Establishment of the Ministry of Defence of the Government of India or ARAI, Pune or the Central. In the process of homologation, the assessee is under compulsion to provide to ARAI, for testing purpose, the auto components as well as entire vehicle, in case it wants to upgrade the same and/or import the new vehicle. After testing, ARAI issues a certificate of homologation for the particular vehicle. The assessee claims that material which was provided to ARAI and once it was returned to the assessee and the same was mainly scrapped as from safety perspective, it cannot be used in new cars. The assessee had debited cost of such material consumed during homologation process and also the cost of certification under the head homologation cost. It was put to the assessee that what happens to the engines in fully built cars or new cars, which were sent for certification and it was fairly pointed out that in case they were in usable condition, the same were not destroyed. In case of any technical variation in any existing vehicle or any of the components that the assessee wants to introduce in the existing vehicles, it was incumbent upon the assessee to get homologation certificate before any change was so introduced. Another expenditure which was incurred was that ARAI may in random, choose any car (as produced) for conducting conformity of production. Hence, it were not only the initial stage for which specifications need to be approved from ARAI but even for the existing vehicles, random checks were made that the assessee was manufacturing the same in conformity with the procedure laid down. The expenditure thus, laid out was for the purpose of smooth running of business and the revenue expenditure merits to be allowed in the hands of assessee. The assessee had also filed breakup of homologation expenses incurred during the year under consideration and we have perused the same. Hence, there is no merit in the stand of authorities below in disallowing the same on the ground that the said expenditure may have enduring benefit to the business of assessee.

24. The Hon’ble Supreme Court in Empire Jute Co. Ltd. Vs. CIT (1980) 124 ITR 1 (SC) had laid down that test of enduring benefit cannot be applied blindly and mechanically, without regard to particular facts and circumstances. Merely because the aforesaid expenditure results in an enduring benefit would not make such expenditure as capital in nature, as while allowing any expenditure in the hands of assessee, the intent and purpose of expenditure is to be kept in mind and whether the same is incurred for smooth running of business, then, such expenditure is revenue in nature. Accordingly, we direct the Assessing Officer to allow homologation expenses of ₹ 1.25 crores (approx.). The ground of appeal No.8 raised by assessee is thus, allowed.”

29. Respectfully following the aforesaid judgment on the same parity of reasoning Homologation expenses are held as revenue expenditure. Ground No. 17 stands allowed.

30. In the combined result, the appeal of the assessee is partly allowed for statistical purposes.

Order pronounced on this 15^th day of July 2022.