Rule 10B of Income Tax Rules provides methodology for computation of ALP. Under TNMM, ‘net profit’ is used as benchmark for ALP computation. Rule 10B(1)(e)(i) provides for considering “net profit margin realised by the enterprise from an international transaction or SDT entered into with an associated enterprise”. Rule 10B(1)(e)(ii) provides for computation of ‘net profit margin in uncontrolled comparable transactions’. Therefore, while computing net margin realized by the enterprises (tested party as well as comparables) all incomes and expenses that are representative or comprised of business obligation should be considered.
Based on the warranty commitments, the taxpayers make warranty provisions in the books of account. Warranty commitments are incidental to sale and therefore provision for warranty is operating in nature. However, sometimes the taxpayer may make one time special warranty provision due to some defect in goods manufactured. The issue is whether such special warranty provision can be considered as abnormal and therefore non-operating in nature. The Courts have held as follows:
M/s. Toyota Kirloskar Motors (P.) Ltd. v ACIT (2012) 54 SOT 0070 (URO), [2012] 28 taxmann.com 293 (Bang Trib) – The taxpayer company was engaged in the manufacture and trading of automobile passenger cars. The taxpayer claimed that special one time warranty provision should be treated as abnormal and excluded from costs while computing margins under TNMM. The ITAT observed that in normal business operations of the kind the taxpayer is involved in, namely, manufacture and sale of passenger cars, warranty would be attached and will form part of operative expenditure. However, from the facts on record, it is clear that the special warranty provision of Rs 15.90 crore to warranty costs was a special, one time provision made to overcome the defects in the exhaust system of the automobile manufactured by the taxpayer in the relevant period. The ITAT observed that in that sense, it is clearly an extraordinary expense of a non-recurring nature and should be excluded from operating costs. The ITAT therefore held that the one-time special warranty provision, arising out of an extraordinary event, viz, manufacturing defect in exhaust of passenger vehicle in the relevant period should be considered as non-operating expenditure.