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  • 2013

S. 14A disallowance can be made even if there is no exempt income

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ITAT MUMBAI BENCH ‘K’

Stream International Services (P.) Ltd.

versus

Assistant Director of Income-tax (International Taxation)

IT Appeal No. 8997 (Mum.) of 2010
[ASSESSMENT YEAR 2006-07]

JANUARY  11, 2013

ORDER

R.S. Syal, Accountant Member

This appeal by the assessee emanates from the order passed by the Assessing Officer u/s 143(3) read with section 144C of the Act on 14.10.2010 in relation to the assessment year 2006-2007.

2. The first ground is against the confirmation of disallowance u/s 14A to the tune of Rs. 16,55,850. Briefly stated the facts of the case are that the assessee made investments of Rs. 33,11,70,086 in Infowayaz International Private Limited in the past. Neither any fresh investment was made in the current year in the securities fetching exempt income nor any exempt income was earned. No disallowance was offered under section 14A by claiming that no expenditure was incurred for earning such exempt income. The Assessing Officer, relying on the prescription of section 14A read with Rule 8D, computed the disallowance in the draft order. When the matter came up before the Dispute Resolution Panel, it directed the Assessing Officer to compute the disallowance by considering the details of direct and indirect expenses to be furnished by the assessee before him. No disallowance was made towards interest in the final order passed by the AO u/s 143(3) read with section 144C. However, the disallowance was computed towards expenditure at the rate of 0.5% of the investment. Such disallowance was made by considering the mandate of Rule 8D. The assessee is aggrieved against this disallowance.

3. After considering the rival submissions and perusing the relevant material on record, we find that the Hon’ble jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81 has held that the disallowance u/s 14A is required to be made as per Rule 8D in relation to the assessment year 2008-09 and subsequent years. For the earlier years, the direction is to compute the disallowance on some ‘reasonable basis’. As the assessment year under consideration is 2006-07, the disallowance is required on some reasonable basis and not as per rule 8D. As the AO has applied rule 8D, his action cannot be countenanced. The ld. counsel for the assessee contended that since no exempt income was realized in the previous year relevant to the assessment year under consideration, so no disallowance u/s 14A was called for. It is observed that the Special Bench of the Tribunal in the case of Cheminvest Ltd. v. ITO [2009] 121 ITD 318 (Delhi)(SB) has held that the disallowance u/s 14A is warranted even if there is no exempt income. In the absence of any judgment of the Hon’ble High Court on the question, the Special Bench decision is binding on the other Benches of the Tribunal. Respectfully following the afore quoted Special Bench order, we uphold, in principle, the action of the AO in computing disallowance u/s 14A even in the absence of any exempt income. However, the computation of the disallowable amount of expenses is restored to the file of A.O. to be done in accordance with the decision of the Hon’ble jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra).

4. Ground no.2 of the appeal is against treating rental income earned on leasehold premises from M/s. Accenture Services Private Limited as “Income from house property”. During the course of assessment proceedings it was found that the assessee had taken three floors of a building on lease for its business purpose. Out of the three floors, the assessee sublet one of the floors to M/s. Accenture Services Private Limited and received rent of Rs. 2,20,24,192. This amount was treated as business income. The assessee claimed deduction for expenses of Rs. 1,11,84,160 as rent and maintenance paid and Rs. 7,93,554 as depreciation on leasehold improvements. On being show caused as to why the receipt be not considered as “Income from house property”, the assessee stated that it had occupied all the three floors at the beginning of the year for its business purposes. Due to the availability of excess capacity with the company, the first floor of the premise was subleased to M/s. Accenture Services Private Limited in August 2005 which remained let out till April 2006. A copy of the sublease agreement was also submitted. It was, thus claimed that the amount of receipt be considered as business income. Not convinced, the Assessing Officer treated the sum of Rs. 2.20 crore earned from subletting of leasehold premises as “Income from house property”. The expenses so claimed by the assessee were consequently disallowed.

5. We have heard the rival submissions and perused the relevant material on record. On a specific query, the learned AR submitted that the premises were taken on lease by the assessee for a period of three years. It is seen that only one floor was subleased to M/s. Accenture Services Private Limited for a short period from August 2005 to April 2006 as it was not required by the assessee at the relevant time. Now the question before us is as to whether the rental income so realized from subletting of first floor is of the nature of income given under the head ‘Income from house property’. Section 22 of the Income-tax Act, 1961 clearly provides that the annual value of a property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner, shall be chargeable to income-tax under the head “Income from house property”. The expression “Owner of house property” has been defined in section 27. Admittedly clauses (i), (ii), (iii) and (iiia) of section 27 have no application in the extant facts. Clause (iiib) of section 27, which has been pressed into service by the ld. DR, provides that “a person who acquires any rights (excluding any rights by way of a lease from month to month or for a period not exceeding one year) in or with respect to any building or part thereof, by virtue of any such transaction as is referred to in clause (f) of section 269UA, shall be deemed to be the owner of that building or part thereof ;”. In turn, section 269UA(f) defines “transfer” in relation to an immovable property to mean ‘transfer of such property by way of sale or exchange or lease for a term of not less than twelve years, …….’. It, therefore, follows that in order to be covered under section 22, it is sine qua non that the assessee must be the owner of the house property as per section 27 read with section 269UA(f). Reverting to the facts of the instant case, it is manifest that the assessee is not the owner of the property. It cannot also be considered as deemed owner of house property within the meaning of section 27 because it took property on lease for a period of three years. Since the assessee was neither the owner nor the deemed owner of the house property, applying the provisions of section 22, the annual value of such property could not have been charged to tax under the head “Income from house property”. As it is a case of simple subletting or property, not facilitating the carrying on of the assessee’s business in any manner, the rental income so realized by the assessee in the present circumstances cannot be considered as ‘Business income’. In such a situation, it is directed that the same should be included under the head ‘Income from other sources’. The impugned order on this issue is set aside and the matter is restored to the file of the AO for doing the needful accordingly. The Assessing Officer will allow eligible deductions and allowances as per the relevant provisions under Chapter IV-F. While allowing such deductions, the Assessing Officer will also ensure that no deduction is doubly claimed/allowed, firstly, in computing of income under the head “Profits and gains of business or profession” and then under the head “Income from other sources”. This ground is disposed off accordingly.

6. Ground no.3 about treating the interest income of Rs. 7,77,291 as ‘Income from other sources’ was not pressed by the learned AR. The same is, therefore, dismissed.

7. Last ground of the appeal is against the confirmation of transfer pricing adjustment of Rs. 2,20,39,947. Before proceeding to decide this ground on merits, it is imperative to note that the assessee modified ground no.4 also to encompass the challenge to the inclusion of certain comparable cases. The ld. DR raised objection to such modification of the ground by arguing that the amendment having been carried out after the time limit for filing appeal, should be rejected and the ground as taken in memo of appeal be considered. There is hardly any substance in the argument. Admittedly the appeal was filed in time, inter alia, taking up ground on this issue in the original memo of appeal. Now the assessee has simply amended the ground already taken. It cannot even be called as an additional ground of appeal empowering the opposite side to take objection to its admission. This contention is sans merit and hence repelled.

8. Briefly stated the facts of the case are that the assessee is engaged in the business of providing IT enabled services to Stream US and Stream Europe through its call centre located in Mumbai. It entered into certain international transactions with its associated enterprises (AEs). A reference u/s 92CA(1) was made by the A.O to the Transfer Pricing Officer (TPO) for determination of Arm’s Length Price (ALP) in respect of international transactions done by the assessee during the year under consideration. The assessee declared operating profit on total cost (OP/TC) at 15%. It applied Transactional Net Margin Method (TNMM) as the most appropriate method. The arm’s length percentage of OP to TC was worked out at 7.31% on the basis of current year’s data and 9.93% on the basis of multiple year data. The assessee chose 15 comparable cases for working out OP/TC at 7.31% as per current year’s data. The TPO included certain new cases at his own and ignored certain cases considered by the assessee. Eventually, the TPO took 13 cases as comparables and determined OP/TC at 24%. In such process of vetting and selection of cases, the TPO inter alia applied filters of (i) number of companies with less than 25% related party transactions, and (ii) companies with export revenue more than 25% of the revenues. Following is the chart showing comparable cases finally chosen by the TPO along with amount of sales and OP to total cost percentage.

Sr. No.

Company Name

Sales (Rs. in crore)

OP to Total Cost %

1.

Ace Software Exports Limited

4.97

7.72

2.

Allsec Technologies Limited

92.25

28.51

3.

Apex Knowledge Solutions Pvt. Ltd.

4.92

20.48

4.

Asit C Mehta Financial Services Ltd. (Earlier known as Nucleus Netsoft & GIS (India) Ltd.

5.68

34.52

5.

Cosmic Global Ltd. (Seg.)

3.11

16.03

6.

Datamatics Financial Services Ltd. (Seg.)

2.31

24.99

7.

Flextronics Software Systems Ltd. (Seg.)

21.41

14.54

8.

Goldstone Infratch Ltd. (Seg.) (Earlier known as Goldstone Teleservices Ltd.)

5.03

29.01

9.

Maple eSolutions Limited

7.43

32.66

10.

R Systems International Ltd. (Seg.)

9.17

15.11

11.

Spanco Ltd. (Seg.) (Earlier known as Spanco Telesystems & Solutions Ltd.)

82.32

20.86

12.

Transworkss Information Services Limited

163.3

19.56

13.

Vishal Information Technologies Ltd.

25.64

48.03

Average

24.00%

9. Applying the OP/TC at 24%, the TPO recommended an adjustment of Rs. 2.20 crore which came to be made by the A.O. in the final order, after due consideration of the matter by the DRP.

10. At the very outset, the learned Counsel for the assessee submitted that the realm of his objections is restricted only to the inclusion of four cases in the list of comparables given above at Sr. Nos. 6, 8, 9 and 13. We will espouse these cases for consideration one by one by noting the objections raised on behalf of the assessee against their inclusion and the reply tendered by the learned Departmental Representative in favour of the inclusion.

11. The first is M/s. Datamatics Financial Services Limited. It can be observed that the TPO applied filter of “Companies with less than 25% related party transactions”. The learned Counsel for the assessee took us through the Annual accounts of Datamatics Financial Services Limited, and submitted that the gross income of this company for the year ending on 31.03.2006 was at Rs. 2.31 crore as against total expenses of Rs. 1.84 crore. Referring to pages 319 and 320 of the paper book, our attention was drawn towards Annexure-2 to demonstrate that the “Transactions with the Associated Parties within the meaning of section 92A and 92B of the Income-tax Act, 1961″ showed one major transaction with Datamatics Limited towards ‘Re-imbursement of expenses’ at Rs. 99.14 lakh. The learned AR contended that the transactions of Datamatics Financial Services Limited with other AEs amounted to Rs. 14.31 lakh making total of transactions with the AEs at Rs. 1.13 crore. It was submitted that the percentage of transaction with related parties is much more than 25%, being, the filter adopted by the TPO himself and hence the same should be excluded.

12. In the opposition, the learned Departmental Representative contended that the major transaction of Rs. 99.14 lakh of Datamatics Financial Services Limited with Datamatics Limited was towards ‘Reimbursement of expenses’. Since the reimbursement of expenses does not include any profit element, the ld. DR urged that the same be excluded. He stated that once this transaction is excluded, the other transaction of Rs. 14.31 lakh are less than 25% of the total transaction with related parties.

13. We do not find any force in the contention advanced by the learned Departmental Representative for the exclusion of transactions with Datamatics Limited towards ‘Reimbursement of expenses’ from the overall transactions entered into by Datamatics Financial Services Ltd. with its AEs. Section 92F(v) defines ‘transaction’ in the context of transfer pricing provisions to include an arrangement, understanding or action in concert whether or not it is formal or in writing or whether or not it is intended to be enforceable by legal proceeding. There is no reference to any transaction having necessarily including profit element or mark-up so as to fall within the definition of ‘transaction’ under Chapter X of the Income-tax Act. Since the TPO applied filter of having companies with less than 25% related party transactions, it is not open to argue that the transactions of reimbursement of expenses duly reported by Datamatics Financial Services Limited as an ‘international transaction’ within the meaning of section 92B should be ignored simply because they represent reimbursement of expenses. If the contention of the ld. DR that the reimbursement of expenses not involving profit element should not be construed as a transaction, is taken to a logical conclusion, it would mean that all such dealings will cease to be transactions for the purposes of Chapter-X of the Act. Once these dealings are not considered as ‘transactions’, these will also cease to be international transactions, going out of the purview of section 92 itself. Obviously, such a view point is contrary to the clear intention and the language of the relevant provisions. A pure reimbursement of expenses by one AE to another AE is very much a ‘transaction’ as per section 92F(v) and consequently is equally an international transaction as per section 92B requiring consideration as per section 92 of the Act. Be that as it may, the learned Departmental Representative could not demonstrate the fact that such reimbursement of expenses was without any markup. As the so called comparable case of Datamatics Financial Services Limited was included by the TPO in the final list of comparables, in our considered opinion, the same is liable to be excluded as it involves related party transactions at much higher level, as against the filter adopted by the TPO himself, being companies with less than 25% related party transactions. We order accordingly.

14. The inclusion of second case objected to by the ld. AR is that of Goldstone Infratech Limited (Seg) (earlier known as Goldstone Teleservices Limited). Here it is relevant to note that the TPO, inter alia, applied filter of ‘Companies with export revenues more than 25% of the revenues’. Annual accounts of Goldstone Teleservices Limited indicate total revenue of the company at Rs. 30.89 crore from three segments, viz., Telecommunication at Rs. 13.63 crore, BPO at Rs. 5.02 crore and Insulator at Rs. 12.23 crore. The break up of such revenue of Goldstone Teleservices Limited has been provided at page 236 of the paper book. Schedule forming part of the annual accounts of Goldstone Teleservices Limited divulges earnings in foreign currency at Rs. 4.24 lakh. Such detail is available at page 239 of the paper book. When we compare earning in foreign currency at Rs. 4.24 lakh with the earnings of BPO at Rs. 5.02 crore or for that purpose of the entity as a whole at Rs. 30.89 crore, it becomes manifest that this case does not pass through the filter adopted by the TPO, being, the ‘companies whose export revenues are more than 25% of the revenues’.

15. At this stage it is relevant to mention that the assessee earlier included the case of Goldstone Infratech Limited within its Transfer pricing study and the TPO also included the same in his final list of comparables. The learned Counsel for the assessee contended that this case was inadvertently included by the assessee in its list of comparables, which deserves to be excluded. The ld. DR opposed this contention by stating that it is not open to the assessee to argue for the exclusion of any case from the list of comparables, which was included by the assessee itself in such list.

16. Having heard the rival submissions and perused the relevant material on record, we find that the purpose of income tax assessment is to determine correct income of the assessee. As the Revenue cannot allow an assessee to depress his income, in the same manner, it is not permissible to the Revenue to take advantage of the ignorance or mistake of the assessee in offering more than due income. It is trite that no tax can be collected except as per law. Circular No. 14(XI-35) of 1955 dated 1.4.1955 cautions the Officers of the Department from taking advantage of ignorance of an assessee as to his rights. The Hon’ble Bombay High Court in court in the case of Nirmala L. Mehta v. A. Balasubramaniam, CIT [2004] 269 ITR 1 has held that there cannot be any estoppel against the statute. Article 265 of the Constitution of India clearly provides that no tax shall be levied or collected except by authority of law. Similar view has been taken recently by the Hon’ble jurisdictional High Court in Sanchit Software & Solutions (P.) Ltd. v. CIT [2012] 349 ITR 404. In our considered opinion there can be no escape from the proposition that the assessee is entitled to argue at least before the appellate authorities that a wrong stand taken at the time of filing the return of income should be allowed to be modified. The ld. AR has rightly relied on order passed by the Mumbai bench of the Tribunal in the case of A.M. Tod Company India Pvt. Ltd. v. ITO (ITA No. 492/Mum/2006). Vide order dated 24.06.2009, the Tribunal accepted the assessee’s contention for exclusion of certain cases which were wrongly included in the Transfer pricing study but were actually not comparable. It is observed that the Special Bench of the Tribunal in the case of Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 (Chd.) also allowed the assessee to claim exclusion of certain cases from the list of comparables which were inadvertently included by it in its transfer pricing study. In view of the afore-noted discussion and the ratio of the these precedents, we direct the AO/TPO to examine the correctness of the figures placed on record by the assessee in support of its contention that the case of Goldstone Teleservices Limited was wrongly included by it in the list of comparables, which is actually not comparable. We want to make it clear that the above discussion made by us considering the figures given by the learned AR is only for a prima facie ascertainment as to whether this case is passing through the filter chosen by the TPO. The AO/TPO in the fresh proceedings will decide the question of inclusion or exclusion of this case afresh independent of our above observations, albeit keeping in mind the afore-quoted filter of ‘Companies whose export revenues are more than 25% of the revenues’.

17. Third case against is that of Maple eSolutions Limited, whose inclusion has been assailed by the ld. AR. It is observed that the TPO excluded the case of Satyam Computers Services on the ground of “Unreliability of data”, although that case satisfied all the relevant criteria chosen by the TPO. The learned Counsel for the assessee contended that the case of Maple eSolutions Limited which was included by the TPO suffered from the same disability. It was argued that the reputation of Rastogi group, owning Maple eSolutions Limited was under serious indictment. Our attention was drawn towards an order passed by the Delhi Bench of the Tribunal in ITO v. CRM Services India (P.) Ltd. [2011] 48 SOT 41 (URO) for the assessment year 2006-2007 vide which the case of Maple eSolutions Limited has been directed to be excluded for this reason alone. We were also taken through an order passed by the Hyderabad Bench of the Tribunal in the case of Capital IQ Information Systems (India) (P.) Ltd. v. Asstt. CIT [2012] 26 taxmann.com 31 wherein the order passed by the Delhi Bench of the Tribunal in the case of CRM Services India (P.) Ltd. (supra) has been followed and the case of Maple eSolutions Limited excluded from the list of comparables. It was therefore, accentuated that the same case of Maple eSolutions Limited should be excluded from the final list of comparables prepared by the TPO. Per contra, the learned Departmental Representative contended that no such objection was taken by the assessee before DRP/TPO. It was argued that the case of Satyam Computers was excluded by the TPO on the ground of mala fides on the part of the company itself whereas in the case of Maple eSolutions Limited, the entire doubt was over the management and not the company.

18. We are unable to uphold the contention raised by the learned Departmental Representative. It is apparent from two orders passed – one by the Delhi Bench and the other by the Hyderabad Bench of the Tribunal – that the case of Maple eSolutions Limited has been directed to be excluded from the list of comparables. As the assessment year under consideration is 2006-2007 and the Delhi Bench of the Tribunal has also considered the same assessment year while directing the exclusion of the case of Maple eSolutions Limited from the list of comparables, we are unable to accept the contention of the ld. DR in this regard. It is more so because no contrary view has been brought by the ld. DR to our notice. Respectfully following the precedents, we direct the exclusion of this case from the final list of comparables.

19. Last case which the learned AR wants to be excluded is that of Vishal Information Technologies Limited (VITL). The learned Counsel for the assessee contended that the assessee is engaged in the business of providing IT enabled services at its own, whereas VITL was outsourcing such services for provision to its customers. This argument was sought to be tendered on the strength of Annual accounts of VITL showing ‘Data entry charges and Vendor payments’ to the tune of Rs. 11.49 crore as against the ‘Personnel cost’ at Rs. 32.01 lakh. These figures in the opinion of the learned AR amply demonstrated that VITL was outsourcing the IT enabled services. Relying on an order passed by the Mumbai Bench of the Tribunal in the case of Asstt. CIT v. Maersk Global Services Centres (India) (P.) Ltd. [2011] 133 ITD 543, the learned AR contended that the Tribunal in this case has held that since VITL outsourced a considerable portion of its business, the same was to be ignored when the assessee in that case was carrying on entire operations by itself. Similar view was shown to have been taken by the Bangalore Bench of the Tribunal in 24/7 Customer.Com (P.) Ltd. v. Dy. CIT [2013] 140 ITD 344 directing the exclusion of VITL’s case. The Bangalore Bench also followed the decision rendered by the Mumbai Bench in the case of Maersk Global Services Centres (India) (P.) Ltd. (supra) to direct the exclusion of the case on the ground that VITL was outsourcing the services. Similar view was shown to have been taken by the Hyderabad Bench of the Tribunal in the case of Brigade Global Services Pvt. Ltd. [ITA No.1494/Hyd/2010]. Vide order dated 26.11.2012, the Bench has directed the exclusion of the case of VITL for the same reason. In the opposition, the learned Departmental Representative submitted that the case of VITL should be allowed to remain in the list of comparables for the two reasons. First, that the assessee itself included this case in its transfer pricing study and second, Hyderabad Bench of the Tribunal in the case of Dy. CIT v. Deloitte Consulting India (P.) Ltd. [2011] 12 taxmann.com 500 directed the inclusion of case of VITL in the list of comparable companies. The ld. DR argued that when an entity outsources the services, its profit is likely to be less vis-à-vis an entity which renders such services at its own. Going by that logic, the ld. DR stated that the case of VITL should continue to be included as it is likely to show lesser percentage of profits than the assessee, which is rendering the services at its own.

20. Having regard to the facts and circumstances of the instant case, we find that the predominant view taken by various Bench of the Tribunal including Mumbai, Bangalore and Hyderabad is to exclude the case of VITL on the reasoning that profit margin in self-provision and outsourcing the services is different. The ld. DR has focused on the inclusion of this case on the ground that the profit margin in the case of the entities outsourcing services is less than that of the providing in-house services. In our considered opinion the contention of the ld. DR has the effect of changing the very criterion for selection of comparable cases. Comparability is judged primarily by seeing the functional similarity and then the capital employed and risks undertaken. Higher or lower profit rate is not and can never be a relevant criteria to judge the comparability. In fact, under the TNMM, it is the eventual profit which is sought to be determined at an arm’s length by considering all the relevant comparable cases. It is the similarity of the functional profile which needs to be taken into consideration as a first step in the process of selection of comparable cases. If the two companies are functionally different and incapable of comparison, then the similarity of the other factors is of no consequence.

21. The relevant factor in choosing comparable cases is to find out similarity in the nature of services rendered. In that view of the matter a case in which services are outsourced and then provided to its customers cannot be compared with the rendering of in-house services. The pertinent criteria for selection of comparable cases should be similarity in the nature of services and not the higher or lower margin of profit in one case vis-à-vis the other. As there is a vast difference in the cases where the services are outsourced or provided in-house, in our considered opinion, there cannot be any comparison between such types of cases. We, therefore, follow the view taken by the Mumbai Bench of the Tribunal in the case of Maersk Global Services Centres (India) (P.) Ltd. (supra), the Bangalore Bench in the case of 24/7 Customer.Com (P.) Ltd. (supra) and Hyderabad Bench in the case of Brigade Global Services (P.) Ltd. (supra) Insofar as the contention of the learned Departmental Representative for not permitting the exclusion of this case because of the assessee voluntarily including this case in the list of comparables is concerned, we refuse to accept the same because of discussion made above in para 16 of this order. Resultantly the assessment order on this comparable case is also set aside and the matter is directed to be decided afresh by the AO/TPO in consonance with our ibid observations.

22. The learned Counsel for the assessee contended that if the four cases are excluded from the list of 13 comparable cases chosen by the TPO, the total margin of OP / TC will come within permissible range as per proviso to section 92C(2). He, therefore, urged that the profit margin of 15% declared by the assessee be declared as at ALP.

23. In our considered view it is premature to hold so. It is relevant to note that we have excluded two cases and the decision as to inclusion or otherwise of the remaining two cases has been restored to the file of AO/TPO. It is only when the AO/TPO decides the fate of these two cases that any decision can be arrived at about the mean of the OP/TC of the remaining cases. The AO/TPO is directed to give effect to the provisions of section 92C after deciding the destiny of such two cases. Needless to say the AO/TPO will allow a reasonable opportunity of being heard to the assessee in such fresh proceedings.

24. In the result, the appeal is partly allowed for statistical purposes.


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