Vodafone Idea Limited Vs ACIT (ITAT Mumbai)
Conclusion: Only the net profit element embedded in the unaccounted sales was taxable and directed the AO to compute the addition by applying a 2% net profit rate, recognising both direct and indirect business expenses evidenced by the seized material.
Held: Pursuant to a search, AO found incriminating material indicating that assessee was engaged in unaccounted sales, purchases, salary payments and other business expenses. Based on seized material relating to a limited period, the AO extrapolated the unaccounted sales for the entire year and allocated such sales between two group companies, including the assessee. AO treated the entire unaccounted sales as taxable income and denied deduction for purchases and other expenses on the ground that the cash payments were hit by section 40A(3). In appeal, CIT (Appeals) held that only the profit embedded in the undisclosed sales could be taxed and sustained the addition by applying a gross profit (GP) rate of 16%. Assessee challenged the application of the GP rate, while the Revenue sought restoration of the addition of the entire sales. Assessee contended that the Commissioner (Appeals) erred in applying a GP rate of 16%, which exceeded the GP disclosed in the regular books of account. It was argued that the seized material itself evidenced not only unaccounted purchases but also salary and other indirect business expenses, making the application of a net profit (NP) rate appropriate. Reliance was placed on judicial precedents holding that only the profit element embedded in undisclosed sales could be assessed. Revenue contended that the AO rightly treated the entire unaccounted sales as income because the assessee had incurred undisclosed cash expenditure, the deduction of which was prohibited under section 40A(3). It was argued that CIT (Appeals) erred in deleting the addition of the entire sales and that the GP rate of 16% ought to be sustained. Tribunal held that the entire amount of undisclosed sales could not be assessed as income since sales necessarily include the cost of goods sold and related business expenditure. The seized material itself established the existence of unaccounted purchases as well as indirect expenses such as salary and other operating costs. Once the Revenue relied upon the seized documents, the presumption regarding the truthfulness of their contents could not be selectively applied only to receipts while disregarding the corresponding expenditure. Following the decisions in President Industries, Balchand Ajit Kumar, Indigo Airways (P.) Ltd., and India Seed House, the Tribunal held that only the net profit embedded in the unaccounted sales was liable to tax. Considering the assessee’s disclosed profit history and the evidence on record, the Tribunal found the GP rate of 16% to be excessive and directed that a net profit rate of 2% be applied to the undisclosed turnover.
FULL TEXT OF THE ORDER OF ITAT MUMBAI
Present appeal filed by assessee is directed against the final assessment order passed by Learned Assessing Officer [hereinafter referred to as the “Ld.AO/Ld.TPO”] u/s 143(3) r.w.s. 144C of the Act on 31/10/2019 pursuant to the directions of the Dispute Resolution Panel-2, New Delhi [hereinafter referred to as the “Ld.DRP”] dated 20/09/2019, for AY 2015-16, on the following grounds of appeal:-
“1. That on the facts and circumstances of the case and in law, the AO has erred in assessing the income of the Appellant at INR 66,32,09,19,130, in pursuance to DRP directions, as against returned income of INR 16,92,86,95,773.
Transfer Pricing Grounds:
2. Transfer pricing (“TP”) adjustment amounting to INR 5,72,83,20,370 in respect of international transaction of payment of royalty:
2.1 That on the facts and circumstances of the case and in law, the AO/DRP/Transfer Pricing Officer (“TPO”) have erred in making an upward TP adjustment of INR 5,72,83,20,370 in respect of the international transaction pertaining to payment of royalty (for use of Vodafone Trademark and Trade name / brand) by determining the arm’s length price at 0.25% of gross sales.
2.2 That on the facts and circumstances of the case and in law, the AO / DRP / TPO have erred in disregarding the royalty agreements selected by the Appellant as comparable for benchmarking the subject transaction under Comparable Uncontrolled Price method (“CUP”) and erroneously accepting agreement between Virgin Enterprises Ltd. and Virgin Mobile USA LLC as a valid comparable.
2.3 Without prejudice, the AO / DRP / TPO have erred in disregarding corroborative Transaction Net Margin Method (“TNMM”), benchmarking analysis adopted by the Appellant; wherein the international transaction of payment of royalty was benchmarked on aggregate basis.
2.4 Without prejudice to the ground of appeal nos. 2.1 to 2.3, the AO/DRP/TPO have erred in making an arbitrary adjustment of INR 5,72,83,20,370 as against the amount of INR 5,72,35,07,935 computed by the TPO himself.
3. TP adjustment amounting to INR 1,22,31,14,408 in respect of international transaction of payment of interest on External Commercial Borrowings (“ECB’s”):
3.1 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in arbitrarily making an upward TP adjustment of INR 1,22,31,14,408 in respect of international transaction of payment of interest on ECB’s alleging that the benchmarking as well as economic analysis done by the Appellant is erroneous.
Payment of interest to Vodafone Overseas Finance Limited (“VOFL”)
3.2 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in determining the arm’s length interest rate at LIBOR + 2.58% in respect of ECB’s extended in Japanese Yen as against interest rate of LIBOR + 4.60% adopted by the Appellant.
3.3 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in not appreciating that since the payment of interest on ECB’s was based on the specific approval of the Reserve Bank of India (“RBI”), no transfer pricing adjustment was warranted.
3.4 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in disregarding the corroborative benchmarking analysis undertaken by the Appellant using Reuters Loan Connector (DealScan) database, without providing any cogent reasons.
3.5 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in rejecting the benchmarking analysis adopted by the Appellant and erroneously / arbitrarily benchmarking the transaction applying inappropriate search criteria.
3.6 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in arbitrarily choosing loan agreements, not comparable to the ECB facility availed by the Appellant, for determining the arm’s length price (“ALP”) of interest paid to VOFL.
3.7 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in not granting economic adjustments being currency risk adjustment, country risk adjustment and subordination adjustment claimed by the Appellant.
Payment of interest to Vodafone Investments Luxembourg SARL (“VLux”)
3.8 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in determining the arm’s length interest rate at LIBOR + 3.72917% in respect of ECB’s extended in US Dollars as against interest rate of LIBOR + 4.75% adopted by the Appellant.
3.9 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in not appreciating that since the payment of interest on ECB’s was based on the specific approval of the RBI, no transfer pricing adjustment was warranted.
3.10 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in disregarding the quotations received from third party banks and corroborative benchmarking analysis undertaken by the Appellant using Reuters Loan Connector (DealScan) database, without providing any cogent reasons.
3.11 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in rejecting the benchmarking analysis adopted by the Appellant and erroneously / arbitrarily benchmarking the transaction applying inappropriate search criteria.
3.12 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in arbitrarily choosing loan agreements, not comparable to the ECB facility availed by the Appellant, for determining the ALP of interest paid to VLux.
3.13 That on the facts and circumstances of the case and in law, the AO / DRP/ TPO have erred in not granting economic adjustments being country risk adjustment and subordination adjustment claimed by the Appellant.
4. TP adjustment amounting to INR 9,29,52,69,832 in respect of international transaction of Advertisement, Marketing and Promotion (“AMP”) expenditure:
4.1 That on the facts and circumstances of the case and in law, the AO/ DRP/TPO have erred in making an upward TP adjustment of INR 9,29,52,69,832 in respect of alleged excessive AMP expenditure incurred by the Appellant, alleging that the Appellant is rendering brand building services to its AEs.
4.2 That on the facts and circumstances of the case and in law, the orders passed by the AO/ DRP/TPO are bad in law as the pre-requisite for applying Chapter-X, being existence of an international transaction between two Associated Enterprises (“AE’s”) under section 92B of the Act, was not established or existed in the absence of an agreement, understanding or arrangement between the AE’s for incurrence of AMP expenditure by the Appellant.
4.3 That on the facts and circumstances of the case and in law, the AO / DRP / TPO erred in re-characterizing the unilateral AMP expenditure, being payments made by Appellant to independent third parties, as an ‘international transaction’ under Chapter X of the Act, particularly when section 92CA of the Act enables the TPO to compute the ALP only of an ‘international transaction’.
VODAFONE IDEA LIMITED 4.4 That on the facts and circumstances of the case and in law, the AO / DRP / TPO erred in holding that the alleged excessive AMP expenditure incurred by the Appellant was towards creation of marketing intangibles, which ensures to the benefit of the AEs.
4.5 That on the facts and circumstances of the case and in law, the AO / DRP/TPO erred in determining the ALP of the alleged excessive AMP expenditure, without appreciating that such expenditure was incurred by the Appellant on its own account for furthering its own telecommunication business, and any incidental benefit, if any, has accrued to its AE does not warrant separate compensation/reimbursement from the AE.
4.6 That on the facts and circumstances of the case and in law, the TPO erred in suo-moto benchmarking the alleged international transaction related to excessive AMP expenditure without their being any order or reference from the AO in relation thereto.
4.7 That on the facts and circumstances of the case and in law, the AO / DRP / TPO grossly erred in applying Bright Line Test (“BLT”) under the garb of Residual Profit Split Method (“RPSM”) for benchmarking the alleged excessive AMP expenditure, without appreciating that BLT has been expressly rejected by various decisions of the High Court.
4.8 That on the facts and circumstances of the case and in law, the AO / DRP / TPO erred in arbitrarily applying RPSM as the most appropriate method for benchmarking the alleged excessive AMP expenditure without appreciating that the conditions prescribed for applicability of PSM under Rule 10B(1)(d) of the Income Tax Rules, 1962 (“Rules”) are not satisfied.
Without prejudice to ground of appeal no. 4.8 above;
4.8.1 The AO / DRP / TPO erred in incorrectly computing the adjustment under RPSM, which is contrary to the provisions of the Act read with Rules.
4.8.2 The AO / DRP / TPO erred in arbitrarily allocating weights to the functions performed, assets employed and risk assumed (“FAR”) for computing profit-split ratio of 80%-20% to allocate the residual profits between the Appellant and the AEs.
4.8.3 The AO / DRP / TPO erred in not restricting the adjustment to 20% of the alleged excessive AMP expenditure even after considering profit split ratio of 80%-20% for allocating the residual profits between the Appellant and the AEs.
4.8.4 The AO / DRP / TPO erred in incorrectly computing the AMP expenditure of comparable companies by not considering certain expenses which were considered as a part of AMP expenditure of the Appellant.
4.8.5 The AO / DRP / TPO erred in considering the Profit Level Indicator (“PLI”) of Operating Profit/Operating Revenue (“OP/OR”) instead of Earnings before interest, tax, depreciation and amortization (“EBITDA”) / OR for the purpose of computation of supernormal profits.
4.8.6 The AO / DRP / TPO have erred in making an adjustment in respect of alleged international transaction of AMP expenditure, without appreciating that higher EBITDA return of the Appellant compensates for any alleged excessive AMP.
4.8.7 The AO / DRP / TPO erred in arbitrarily rejecting Aircel Limited and Tata Teleservices Limited as comparable companies for the purposes of computation of non-routine AMP expenditure and computation of supernormal profits, without providing any cogent reasons.
4.8.8 That on the facts and circumstances of the case and in law, the AO / DRP / TPO erred in not excluding the sales and distribution expenditure from the quantum of alleged excessive AMP expenditure while benchmarking the alleged international transaction, disregarding the various decisions of the High Court.
Corporate Tax Grounds:
5. Disallowance amounting to INR 20,57,50,02,571 in respect of depreciation on right to use spectrum:
5.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in disallowing the claim of depreciation amounting to INR 20,57,50,02,571 in respect of expenditure incurred for acquisition of right to use of 3G spectrum under section 32 of the Act, alleging that the same is amortizable under section 35ABB of the Act.
5.2 That on the facts and circumstances of the case and in law, the AO / DRP erred in not appreciating that the spectrum fees paid was not incurred for the acquisition of right or license for operating telecommunication services as envisaged under section 35ABB of the Act.
5.3 That on the facts and circumstances of the case and in law, the AO / DRP erred in disallowing the claim of depreciation under section 32 of the Act, even after admitting that the expenditure was incurred towards acquisition of an intangible asset.
6. Disallowance of INR 27,75,78,909 being penalty imposed by Department of Telecommunication (“DOT”) for subscriber verification:
6.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in disallowing INR 27,75,78,909, being amount paid to DOT on account of failure to comply with subscriber verification guidelines, alleging it to be penal in nature.
6.2 That on the facts and circumstances of the case and in law the AO / DRP erred in disallowing penalty imposed by DOT without appreciating that the same is paid for breach of contractual liability under the license agreement and not for infraction of any law and is therefore allowable as deduction under section 37(1) of the Act.
7. Disallowance amounting to INR 16,68,00,000 in respect of Asset Restoration Cost (“ARC”) obligation:
7.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in disallowing INR 16,68,00,000 in respect of depreciation on ARC obligation.
7.2 That on the facts and circumstances of the case and in law, the AO / DRP erred in incorrectly computing the depreciation to be disallowed on ARC obligation at INR 16,68,00,000, basis the closing balance of provision, without appreciating that an amount of INR 5,85,94,382 was claimed by the Appellant as depreciation in respect of ARC obligation.
7.2.1 Without prejudice to ground of appeal nos. 8.2, the AO / DRP erred in not restricting the disallowance in respect of ARC obligation to depreciation amounting to INR 5,85,94,382, actually claimed by the Appellant.
7.3 That on the facts and circumstances of the case and in law, the AO / DRP erred in not appreciating that ARC, being directly attributable to the acquisition of capital asset, is includible in cost of telecom towers under section 43(1) of the Act.
7.4 Without prejudice to grounds of appeal nos. 8.1 to 8.3, the AO / DRP erred in not allowing the deduction for provision in respect of ARC obligation on proportionate basis over the period of lease.
7.5 Without prejudice to grounds of appeal nos. 8.1 to 8.4, the AO / DRP erred in not allowing the deduction under section 37(1) of the Act as revenue expenditure in respect of provision for ARC obligation.
7.6 Without prejudice to ground of appeal nos. 8.4 and 8.5, the AO / DRP erred in not allowing the deduction in respect of ARC expenditure amount actually incurred by the Appellant during the year.
8. Disallowance amounting to INR 1,48,70,950 in respect of liabilities written back:
8.1 That on the facts and circumstances of the case and in law, the AO erred in making an addition of INR 1,48,70,950 invoking provisions of section 41(1) and / or section 28(iv) of the Act, in respect of capital account liabilities written back during the subject assessment year. The DRP further erred in not directing the AO to delete the addition in toto made in this regard.
8.2 Without prejudice, that on the facts and circumstances of the case and in law, the AO erred in not giving effect to directions given by DRP by restricting the disallowance to the amount of depreciation actually granted to the Appellant in the earlier year(s).
9. Disallowance amounting to INR 3,06,84,13,975 under section 40(a)(ia) in respect of discount extended to prepaid distributors:
9.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in making disallowance of INR 3,06,84,13,975 under section 40(a)(ia) of the Act on account of non-deduction of tax at source in respect of discount allowed to prepaid distributors.
9.2 That on the facts and circumstances of the case and in law, the AO / DRP erred in holding that relationship between the Appellant and its prepaid distributors is that of principal and agent, therefore the discount extended to prepaid distributors is in the nature of commission warranting deduction of tax at source under section 194H of the Act.
Without prejudice to the above:
9.3 That on the facts and circumstances of the case and in law, the AO / DRP ought not to have made the disallowance under section 40(a)(ia) of the Act as the Appellant was under bonafide belief that no tax was required to be deducted at source on the discount allowed to prepaid distributors.
9.4 That on the facts and circumstances of the case and in law, the AO / DRP erred in not appreciating that even if such charges were liable to tax deduction at source, no disallowance was warranted under section 40(a)(ia) of the Act since tax on the same was paid by the recipient(s) of income.
9.5 The DRP erred in not directing the AO to allow deduction of disallowance made in the subject assessment year under section 40(a)(ia) of the Act, in subsequent year(s), under the first and / or second proviso to section 40(a)(ia) of the Act.
9.6 The DRP erred in not directing, and AO erred in not allowing deduction under the first and / or second proviso to section 40(a)(ia) of the Act, in respect of similar disallowances made for prior assessment years (i.e. AYs 2007-08 to 2014-15).
10. Capitalisation of license fees under section 37(1) of the Act:
10.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in holding that annual license fee payable to DOT, based on percentage of revenue earned, is in the nature of capital expenditure amortizable under section 35ABB of the Act.
10.2 That on the facts and circumstances of the case and in law, the AO / DRP erred in not appreciating that annual revenue share license fee payable to DOT is allowable as deduction under section 37(1) of the Act.
11. Disallowance amounting to INR 56,62,70,569 in respect of payments made to IBM:
11.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in disallowing IT support service charges amounting to INR 1,71,30,00,000 paid to IBM as capital expenditure and restricting the allowance to INR 1,14,67,29,431 by arbitrarily amortizing the same over the period of agreement.
11.2 That on the facts and circumstances of the case and in law, the AO / DRP failed to appreciate that the Appellant did not own the assets and had only received the benefit of the services and / or right to use the assets over the term of the agreement with IBM.
11.3 Without prejudice to above, that on the facts and circumstances of the case and in law, the AO / DRP ought to have allowed depreciation at the rate of 60% under section 32 of the Act on the amount alleged as capital expenditure for acquisition of computer hardware / software.
12. Disallowance amounting to INR 12,78,68,29,868 in respect of royalty WPC expense:
12.1 That on the facts and circumstances of the case and in law, the AO / DRP erred in holding that amount of INR 17,04,91,06,491 incurred for use of spectrum and microwave frequency to WPC wing of DOT as capital expenditure and allowing depreciation of INR 4,26,22,76,623.
12.2 That on the facts and circumstances of the case and in law, the AO / DRP erred in not appreciating that WPC-royalty expense is an expenditure for use of spectrum in the relevant frequencies, based on the revenues earned by the Appellant and therefore allowable as revenue expenditure under section 37(1) of the Act.
12.3 That on the facts and circumstances of the case and in law, the AO / DRP erred in not appreciating that INR 15,49,09,00,000 and not INR 17,04,91,06,491 was incurred by the Appellant for the use of spectrum and microwave frequency to WPC wing of DOT.
12.4 That on the facts and circumstances of the case and in law, the AO / DRP erred in not granting depreciation in respect of royalty WPC expense incurred in assessment years 2012-13 to 2014-15 and capitalized in those years, especially when the AO in the assessment order observed that depreciation is to be granted in respect of expense capitalized in earlier year(s).
13. That on the facts and circumstances of the case and in law, the AO erred in granting short credit of taxes deducted at source.
14. That on the facts and circumstances of the case and in law, the AO erred in levying interest under section 234B and 234C of the Act.
14.1 Without prejudice, the AO erred in incorrectly computing the interest under section 234B and 234C of the Act.
15. That on the facts and circumstances of the case and in law, the AO erred in initiating penalty proceedings under section 271(1)(c) of the Act.
Each of the above grounds is independent and without prejudice to the other grounds of appeal preferred by the Appellant.
The Appellant prays for leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before, or at, the time of hearing, of the appeal.”
2. Brief facts of the case are that, the assessee is engaged in the business of providing telecommunication services. For the year under consideration, it filed its revised return of income declaring Nil income under the normal provisions of the Act and book profit of Rs.514,85,93,299/- under section 115JB of the Act. The return was selected for scrutiny.
