ITAT Mumbai: Rule 8D Fails Without Satisfaction; Asian Paints TP Comparables Excluded

Asian Paints Ltd. Vs ACIT (ITAT Mumbai)

Summary: ITAT Mumbai partly allowed Asian Paints Ltd.’s appeal and partly allowed the Revenue’s appeal for statistical purposes for Assessment Year 2013-14. On Section 14A read with Rule 8D, the Tribunal held that the Assessing Officer proceeded to compute disallowance of Rs.1,82,91,196 without recording the requisite satisfaction regarding the correctness of the assessee’s suo-moto disallowance. Following the assessee’s own case and the principles in Maxopp Investment Ltd. and Godrej & Boyce Manufacturing Company Ltd., the disallowance was deleted. On transfer pricing for support and intragroup services, Axis Integrated Systems Ltd. and Inmacs Management Services Ltd. were directed to be excluded as comparables because the available material did not establish sufficiently comparable activities. As regards letters of comfort/support issued for subsidiaries, the Tribunal followed its decision for the preceding year and held that the letters constituted an international transaction, while sustaining the arm’s length rate of 0.04%. :chatgpt-content-reference{index=”0″}

In the Revenue’s appeal, the Tribunal upheld the CIT(A)’s directions concerning deduction under Section 35(2AB) and followed earlier orders in the assessee’s own case on valuation of damaged stock and additional depreciation. Dealer trip-scheme expenditure was allowed following earlier years, where the expenditure was treated as connected with the assessee’s business and the dealers/distributors were not shown to be agents attracting Section 194H. The Tribunal also dealt with waiver of royalty, CSR expenditure, sundry balances written off and subsidy received under Maharashtra’s Package Scheme of Incentives, 2007. CSR expenditure incurred before the prospective operation of Explanation 2 to Section 37(1) was allowed. The sundry-balance issue was restored to the AO for de novo adjudication. Applying the purpose test laid down in the subsidy decisions, the Tribunal held that the Maharashtra subsidy was capital in nature because its object was to encourage establishment of industries in less-developed areas rather than to enable profitable operation of an existing business. The assessee’s appeal was partly allowed and the Revenue’s appeal was partly allowed for statistical purposes.

Cases Discussed

• Asian Paints Ltd. v/s ACIT, ITA No.5363/Mum./2017, order dated 01/03/2024, AY 2012-13 (ITAT Mumbai) — Followed on Section 14A; the Tribunal had deleted the disallowance because the AO had not recorded proper satisfaction regarding the correctness of the assessee’s suo-moto disallowance.
• Maxopp Investment Ltd v. CIT, [2018] 402 ITR 640 (SC) — Relied upon for the requirement that before applying the prescribed method under Rule 8D, the AO must record satisfaction regarding the incorrectness of the assessee’s claim having regard to its accounts.
• Godrej & Boyce Manufacturing Company Ltd. Vs DCIT, [2017] 394 ITR 449 (SC) — Relied upon for the proposition that Section 14A(2)/(3) and Rule 8D become applicable only after the AO records the requisite dissatisfaction with the assessee’s claim.
• CIT v/s M/s Asian Paints Ltd., ITA No.1564 of 2016, order dated 06/04/2019, AY 2008-09 (Bombay High Court) — Followed for the proposition that invocation of Rule 8D is impermissible in the absence of recording non-satisfaction in terms of Section 14A(2).
• Asian Paints Ltd v/s Addl.CIT, ITA No.2754/Mum./2014, order dated 03/02/2021, AY 2009-10 (ITAT Mumbai) — Earlier coordinate-bench decision concerning letters of comfort/support; distinguished in the later year because of the assessee’s undertakings and treatment of the letters as contingent liabilities.
• Asian Paints Ltd v/s Addl. CIT, ITA No.2178/Mum./2012, order dated 20/12/2013, AY 2007-08 (ITAT Mumbai) — Followed on Section 35(2AB); the issue was restored to the AO for verification whether the expenditure was incurred on eligible research and development.
• CIT vs Cadila Health Care Ltd., 87 DTR 56 (Gujarat High Court) — Considered in the earlier Asian Paints order while examining the effect of certification by the prescribed authority on deduction under Section 35(2AB).
• ACIT vs Torrent Pharmaceuticals Ltd., ITA No.3569/Ahd/2004, order dated 13.11.2009 (ITAT Ahmedabad) — Relied upon in the earlier Asian Paints order concerning whether Section 35(2AB) deduction could be restricted merely to the amount stated in the DSIR certificate.
• Addl. CIT v/s Asian Paints Ltd., ITA No.749/Mum./2017, order dated 28/07/2022, AY 2011-12 (ITAT Mumbai) — Followed on valuation of damaged stock; the earlier order had sustained the CIT(A)’s treatment restricting the adjustment to 0.5% of closing stock.
• ACIT v/s Asian Paints Ltd., ITA No.4675/Mum/2015, order dated 23/02/2022, AY 2010-11 (ITAT Mumbai) — Followed in relation to dealer trip-scheme expenditure and other recurring issues decided in the assessee’s favour.
• CIT, Pune vs. Intervet India Pvt. Ltd., ITA 1616/2011 (Bombay High Court) — Cited by the assessee in the earlier order concerning the contention that dealer/distributor arrangements did not constitute agency attracting Section 194H.
• Pr. GT vs. Reliance Communication Infrastructure Ltd., ITA No.702 of 12017 (Bombay High Court) — Cited by the assessee in support of its position concerning dealer/distributor incentives and Section 194H.
• DOT vs. BCH Electric Ltd., ITA 1336/Kol/2012 — Cited by the assessee on the dealer/distributor trip-scheme issue.
• ACIT vs. Raymond Ltd., ITA 5889/M/10 — Cited by the assessee on the dealer/distributor trip-scheme issue.
• CIT vs. Piramal Healthcare Ltd., 230 Taxman 505 (Bom) — Cited by the assessee on the dealer/distributor trip-scheme issue.
• CIT vs. Qatar Airways, 332 ITR 253 (Bom) — Cited by the assessee on the dealer/distributor trip-scheme issue.
• Radhasaomi Satsang vs. CIT, 193 ITR 321 (SC) — Cited in the earlier Asian Paints order in connection with the rule of consistency.
• Pr.CIT v/s PEC Ltd., [2023] 146 taxmann.com 407 (Delhi High Court) — Followed for the proposition that Explanation 2 to Section 37(1), introduced with effect from 01/04/2015, is prospective and CSR expenditure incurred prior thereto could be allowed.
• CIT v/s Ponni Sugars and Chemicals Ltd., [2008] 306 ITR 392 (SC) — Applied for the purpose test in determining whether government subsidy is a capital or revenue receipt.
• CIT v/s Kirloskar Oil Engines Ltd., [2014] 364 ITR 88 (Bombay High Court) — Followed for treating assistance intended to enable setting up of a new unit as capital in nature.
• Sahney Steel & Press Works Ltd. v. CIT, [1997] 228 ITR 253 (SC) — Considered along with Ponni Sugars for applying the purpose test to determine the character of the Maharashtra incentive/subsidy.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

The present cross-appeal has been filed challenging the impugned order dated 22/11/2017, passed under section 250 of the Income Tax Act, 1961 (“the Act”) by the learned Commissioner of Income Tax (Appeals)–55, Mumbai, [“learned CIT(A)”], for the assessment year 2013–14.

2. The brief facts of the case are that the assessee is a company and is engaged in the business of manufacturing paints and enamels. For the year under consideration, the assessee filed its return of income on 28/11/2013 declaring a total income of Rs.1259,97,53,980. Subsequently, the assessee revised its return of income declaring a total income of Rs.1248,74,49,480. The return filed by the assessee was selected for scrutiny and statutory notices under section 143(2) as well as section 142(1) were issued and served on the assessee. The Assessing Officer (“AO”) vide order dated 25/01/2017 passed under section 143(3) read with section 144C(3) of the Act assessed the total income of the assessee at Rs.1351,78,51,596, under normal provisions of the Act, after making certain additions/disallowances. The learned CIT(A), vide impugned order, granted partial relief to the assessee. Being aggrieved, both the assessee as well as the Revenue are in appeal before us.

ITA No.268/Mum./2018 Assessee’s Appeal – A.Y. 2013–14

3. In its appeal, the assessee has raised the following grounds:–

1) The learned Commissioner of Income Tax (Appeals) -55, Mumbai erred in applying Rule 8D and disallowed a sum of Rs. 69.44 lacs (net of Rs. 23.87 lacs offered by assessee) u/s 14A of the Income Tax Act, 1961.

2) The learned Commissioner of Income Tax (Appeals) -55, Mumbai disallowed Rs.26.79 lacs on account of Transfer pricing adjustments for low mark up on support service provided to associated enterprises.

3) The learned Commissioner of Income Tax (Appeals) -55. Mumbai erred in disallowing Rs.5.98 lacs on account of Transfer Pricing adjustments for non- recovery of charges for providing letter of support/comfort.

4) The learned Commissioner of Income Tax (Appeals)-55, Mumbai erred in confirming an ad hoc addition of Rs.84.41 lacs (net) on account of non- inclusion of damaged stock in valuation of closing stock.

5) The Appellant craves leave to add, amend, alter, modify, delete or change all or any of the above ground on or before the date of hearing of this appeal.”

4. The issue arising in ground no.1, raised in assessee’s appeal, pertains to disallowance under section 14A of the Act.

5. The brief facts of the case pertaining to this issue, as emanating from the record, are: During the year under consideration, the assessee earned dividend income from domestic companies/mutual funds of Rs.31,69,67,788, which was claimed as exempt under section 10(34) of the Act and also earned interest on tax-free REC bonds amounting to Rs.2,16,86,381. The assessee suo-moto made a disallowance of Rs.23.86 lakh as an expense incurred for earning the aforesaid exempt income. The AO vide order passed under section 143(3) read with section 144C(3) of the Act by applying the provisions of Rule 8D of the Income Tax Rules, 1962 (“the Rules”) computed the disallowance of Rs.1,82,91,196 under section 14A of the Act after considering the suo-moto disallowance of Rs.23,86,531 made by the assessee. The learned CIT(A), vide impugned order, restricted the disallowance made under section 14A read with Rule 8D to Rs.93,30,985 after granting relief to the assessee with respect to the proportionate interest amount computed on interest incurred for the normal running of the business, following the approach adopted by its predecessor in earlier years in assessee’s own case. Being aggrieved, both the assessee as well as the Revenue are in appeal before us.

6. During the hearing, the learned Authorised Representative (“learned AR”) made similar arguments as were made in assessee’s appeal for the assessment year 2012-13 and submitted that recording of satisfaction is a prerequisite for invoking the provisions of section 14A of the Act. However, in the present case, the AO did not record any satisfaction regarding the rejection of assessee’s plea. The learned AR further submitted that in preceding years disallowance made under section 14A of the Act has been deleted in the absence of any satisfaction being recorded by the AO.

7. On the other hand, the learned Departmental Representative (“learned DR”) vehemently relied upon the order passed by the AO.

8. We have considered the submissions of both sides and perused the material available on record. Undisputedly, in the present case, the assessee earned a dividend income of Rs.31,69,67,788 from domestic companies/mutual funds and also on interest on tax-free REC bonds amounting to Rs.2,16,86,381, which has been claimed as exempt under section 10 of the Act. Further, there is also no dispute regarding the fact that the assessee while computing its taxable income suo-moto disallowed an amount of Rs.23,86,531 as an expenditure incurred for earning the aforesaid exempt income. As per the assessee, the aforesaid suo-moto disallowance is based on the report obtained from the accountant, who after verifying assessee’s books of accounts and relevant records has estimated the amount of disallowance. The working of aforesaid suo-moto disallowance made by the assessee, forms part of the paper book on page 329, as under:

9. We find that while deciding a similar issue in favour of the assessee, the coordinate bench of the Tribunal in assessee’s own case in Asian Paints Ltd. v/s ACIT, in ITA No.5363/Mum./2017, vide order dated 01/03/2024, for the assessment year 2012-13, observed as under:-

“8. We have considered the submissions of both sides and perused the material available on record. Undisputedly, in the present case, the assessee earned a dividend income of Rs.40.57 crore, which has been claimed as exempt under section 10 of the Act. Further, there is also no dispute regarding the fact that the assessee while computing its taxable income suo-moto disallowed an amount of Rs.24,45,540 as an expenditure incurred for earning the aforesaid exempt income. As per the assessee, the aforesaid suo-moto disallowance is the salary cost in respect of the time spent by its employees on carrying out the investment-related activity, which has been computed as under:

9. It is the plea of the assessee that it has not engaged any specific staff for investment activity and the same is being carried out by the existing staff. Further, no incremental expenditure has been incurred on staff and other administrative activities for earning the exempt income. It is evident from the record that the AO disagreed with the correctness of the claim of expenditure made by the assessee and held that adequate interest and administrative expenses have not been disallowed for earning the exempt income. Accordingly, the AO proceeded to compute the disallowance of Rs.1,51,24,084/- under section 14A read with Rule 8D of the Rules, after considering the suo-moto disallowance made by the assessee.

10. Before proceeding further, it is pertinent to note certain relevant provisions of the Act, which are necessary for adjudication of the issue at hand. Section 10 of the Act deals with income which does not form part of the total income of the assessee. Section 14A of the Act provides that no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act. Further, section 14A(2) of the Act, reads as under:

“(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does in form part of the total income under this Act”. (emphasis supplied)

11. Thus, if the AO is not satisfied with the correctness of the claim of the assessee in respect of expenditure incurred in relation to income which does not form part of the total income, after having regard to the accounts of the assessee, the AO can determine the amount of such expenditure. The Hon’ble Supreme Court in Maxopp Investment Ltd v. CIT: [2018] 402 ITR 640 (SC), while emphasising the aspect of recording satisfaction by the AO, observed as under:

“41. Having regard to the language of section 14A(2) of the Act, read with rule 8D of the Rules, we also make it clear that before applying the theory of apportionment, the Assessing Officer needs to record satisfaction that having regard to the kind of the assessee, suo motu disallowance under section 14A was not correct. It will be in those cases where the assessee in his return has himself apportioned but the Assessing Officer was not accepting the said apportionment. In that eventuality, it will have to record its satisfaction to this effect. Further, while recording such a satisfaction, the nature of the loan taken by the assessee for purchasing the shares/ making the investment in shares is to be examined by the Assessing Officer.”

Further, the Hon’ble Supreme Court in Godrej & Boyce Manufacturing Company Ltd. Vs DCIT: [2017] 394 ITR 449 (SC), observed as under:

“37. We do not see how in the aforesaid fact situation a different view could have been taken for the Assessment Year 2002-2003. Sub-sections (2) and (3) of Section 14A of the Act read with Rule 8D of the Rules merely prescribe a formula for determination of expenditure incurred in relation to income which does not form part of the total income under the Act in a situation where the Assessing Officer is not satisfied with the claim of the assessee. Whether such determination is to be made on application of the formula prescribed under Rule 8D or in the best judgment of the Assessing Officer, what the law postulates is the requirement of a satisfaction in the Assessing Officer that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee. It is only thereafter that the provisions of Section 14A(2) and (3) read with Rule 8D of the Rules or a best judgment determination, as earlier prevailing, would become applicable.” (emphasis supplied)

12. Therefore, the satisfaction as required to be recorded under the provisions of section 14A of the Act is not limited to merely disagreeing with the submission of the assessee and requires that the AO should also provide the basis for reaching such a conclusion, after having regard to the accounts of the assessee. However, as noted above, in the present case the AO merely proceeded to compute the disallowance under section 14A read with Rule 8D without examining the correctness of the claim of the assessee regarding expenditure incurred for earning the exempt income. It is evident from the record that the assessee’s own funds, i.e. share capital and reserves & surplus, are Rs.2487.78 crore, while investment in tax-free securities is only limited to Rs.165.07 crore and therefore it can be presumed that the assessee had sufficient own funds for making the aforesaid investment in tax-free securities. Further, it is also evident from the record that the assessee has computed the suo-moto disallowance on the basis of the salary cost of the designated employees, however, there is no material available on record to show that the AO has recorded the requisite satisfaction to the effect that the computation made by the assessee is incorrect having regard to the accounts of the assessee.

13. We find that the Hon’ble jurisdictional High Court in CIT v/s M/s Asian Paints Ltd., in ITA No. 1564 of 2016, vide order dated 06/04/2019, for the assessment year 2008-09, while dismissing the appeal filed by the Revenue on a similar issue held that in the absence of recording of non-satisfaction in terms of section 14A(2) of the Act, invocation of Rule 8D is not permissible. The relevant findings of the Hon’ble jurisdictional High Court, in the aforesaid decision, are reproduced as under:-

“4. Regarding question no.(c):-

(a) In its return of income, the respondent made a suo-moto disallowance of Rs.15.21 lakhs being the expenditure incurred to earn exempt income under Section 14A of the Act. The Assessing Officer disregarded the same and proceeded to disallow an amount of Rs.1.10 crores under Section 14A of the Act read with Rule 8D of the Rules as expenditure incurred to earn exempt income. Thus, adding Rs.1.10 crores to the income of the respondent.

(b) Being aggrieved, the respondent filed an appeal to the CIT(A) but without success.

(c) On further appeal, the impugned order of the Tribunal while allowing the appeal held that before invoking the provisions of Rule 8D of the Income Tax Rules, the Assessing Officer has to record his non satisfaction with the suo moto disallowance of expenditure made towards earning exempt income by the respondent. This exercise not having been carried out by the Assessing Officer before applying Rule 8D of the Income Tax Ru’es, the disallowance of expenditure to earn exempt income cannot be sustained.

(d) This issue is no longer res integra as the Apex Court in Gorej & Boyce Mfg. Co. Ltd. Vs. Dy. CIT, 394 ITR 449 decided the issue in favour of the respondent. In the above case, the Supreme Court has while considering the issue of disallowing of expenditure incurred to earn exempt income observed as under:-

“Whether such determination is to be made on application of the formula prescribed under rule 8D or in the best judgment of the Assessing Officer, what the law postulates is the requirement of a satisfaction in the Assessing Officer that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee. It is only thereafter that the provisions of section 14A (2) and (3) read with rule 8D of the Rules or a best judgment determination, as earlier prevailing, would become applicable.”

Thus, Rule 8D of the Rules cannot be invoked where the suo moto disallowance made by the respondent assessee is not found to be satisfactory by the Assessing Officer having regard to the accounts of the assessee. In the absence of recording the aforesaid fact of non- satisfaction in terms of Section 14A(2) of the Act, invocation of Rule 8D is not permissible.

(e) Therefore, in view of the above decision of the Apex Court, this question also does not give rise to any substantial question of law. Thus, not entertained.”

14. Since, in the present case, no proper satisfaction has been recorded by the AO in terms of the provisions of section 14A(2) of the Act, having regard to the accounts of the assessee, about the correctness of the claim of the assessee in respect of expenditure incurred in relation to exempt income, respectfully following the aforesaid decisions, we do not find any reason for upholding the disallowance made by the AO under section 14A read with Rule 8D of the Rules. Accordingly, the same is directed to be deleted. As a result, ground no.1 raised in assessee’s appeal is allowed.”

10. In the present case, it is evident from the record that the AO without recording any satisfaction regarding the claim of the assessee in respect of expenditure incurred in relation to exempt income proceeded to compute the disallowance of Rs.1,82,91,196/- under section 14A read with Rule 8D of the Rules. Therefore, respectfully following the decision rendered in assessee’s own case cited supra, we do not find any reason for upholding the disallowance made by the AO under section 14A read with Rule 8D of the Rules. Accordingly, the same is directed to be deleted. As a result, ground no.1 raised in assessee’s appeal is allowed.

11. The issue arising in ground no.2, raised in assessee’s appeal, pertains to transfer pricing adjustment on account of low markup on support services provided to the associated enterprises.

12. The brief facts of the case pertaining to this issue, as emanating from the record, are: During the year under consideration, the assessee, inter-alia, entered into international transaction with its associated enterprises and received payment towards the provision of support services and intragroup services. The assessee provided support services in the nature of (i) time cost recovery of engineering, legal, HR, and other miscellaneous support functions, and (ii) software support for the purpose of book keeping and other systems support to its overseas associated enterprises. The assessee charged its overseas associated enterprises on a cost +12% basis. Further, the assessee also provided certain centralised intragroup services in the nature of supply chain, marketing, human resources, legal, systems, etc. to its associated enterprises without any consideration but for which arm’s length amount was offered to tax in the return of income on the total cost incurred towards rendering the said services plus a markup of 12%. For benchmarking this transaction, the assessee used the Transactional Net Margin Method (“TNMM”) as the most appropriate method with the Profit Level Indicator (“PLI”) of Operating Profit to Operating Cost (“OP/OC”). By considering itself as the tested party, the assessee identified five comparable companies with a single- year weighted margin of 8.46%. As the assessee has charged a markup of 12% on cost for these transactions, accordingly, it claimed that the international transaction of provision of support services and intragroup services is at arm’s length price (“ALP”).

13. The AO made reference to the Transfer Pricing Officer (“TPO”) for the determination of ALP of the aforesaid international transaction. The TPO vide order dated 21/10/2016 passed under section 92CA(3) of the Act rejected two companies selected as comparables by the assessee and included two other companies i.e. Axis Intergrated Systems Ltd. and Inmacs Management Services Ltd. as comparables to the assessee. Accordingly, by considering the following five companies as comparables to the assessee, the TPO arrived at average OP/OC of 22.82%:-

14. By applying the arm’s length margin of 22.82% as computed above, the TPO, inter-alia, proposed an upward adjustment of Rs.26,79,717 with respect to international transaction of provision of support services and intragroup services. In conformity, the AO, inter-alia, passed the order under section 143(3) read with section 144C(3) of the Act. In appeal, learned CIT(A) vide impugned order dated 22/11/2017 dismissed the ground raised by the assessee and upheld the benchmarking done by the TPO. Being aggrieved, the assessee is in appeal before us.

15. During the hearing, learned AR submitted that if Axis Integrated Systems Ltd. and Inmacs Management Services Ltd., selected as comparable by the TPO, are directed to be excluded, then the entire transfer pricing adjustment made in respect of international transaction of provision of support services and intragroup services will be deleted. In view of the above, we have confined our findings only in respect of the aforesaid two comparables.

i) Axis Integrated Systems Ltd.

16. The first comparable under dispute is Axis Integrated Systems Ltd. This company was included as comparable by the TPO vide order passed under section 92CA(3) of the Act on the basis that this company is engaged in export licensing services and procedures and EXIM consideration, service tax audit services, money exchange services, etc. and these activities are in the nature of business support services as rendered by the assessee. The TPO rejected the contention of the assessee that this company is engaged in providing licensing services and also traded in Digital Certificate. The learned CIT(A) did not agree with the submissions of the assessee challenging the inclusion of this company as comparable to the assessee. Being aggrieved, the assessee is in appeal before us.

17. We have considered the submissions of both sides and perused the material available on record. As per the assessee, it is difficult to trace the exact business description/activity of the company undertaken during the year, and therefore this company cannot be considered as comparable to the assessee. From the perusal of the annual report of Axis Integrated Systems Ltd., for the year ending 31/03/2013, forming part of the supplementary factual paper book from pages 8-30, we find that there is no description of the business undertaken by this company during the year under consideration. Further, the company has claimed to have earned its revenue from operations from sales, liaison charges, and reimbursement of expenses. It is pertinent to note that there are no details as to from where these liaison charges were earned. From Note 26 of the financial statement pertaining to additional disclosure, we find that the company has traded in Digital Certificate and quantitative details of the trade have been mentioned therein. Accordingly, in view of the information as provided in the annual report of this company, we agree with the submissions of the assessee that the nature of activities undertaken by this company is ambiguous and in any case cannot be said to be similar to the business support services rendered by the assessee, during the year under consideration, to its associated enterprises. Further, there is no material available on record to show that this company is engaged in the activities noted by the TPO in para-5.3 of its order. In view of our aforesaid findings, we are of the considered view that Axis Integrated Systems Ltd. is not comparable to the assessee, and accordingly, we direct the exclusion of this company for benchmarking the international transaction of provision of support services and intragroup services.

ii) Inmacs Management Services Ltd.

18. The next comparable under dispute is Inmacs Management Services Ltd. This company was included as comparable by the TPO vide order passed under section 92CA(3) of the Act on the basis that the consultancy and professional services provided by the company are in line with the services provided by the assessee. The learned CIT(A) did not agree with the submissions of the assessee challenging the inclusion of this company as comparable to the assessee. Being aggrieved, the assessee is in appeal before us.

19. We have considered the submissions of both sides and perused the material available on record. With respect to this company also, the assessee raised a similar plea that it is difficult to trace the exact business description/activity of the company undertaken during the year, and therefore this company cannot be considered comparable to the assessee. From the perusal of the annual report of Inmacs Management Services Ltd. for the year ending 31/03/2013, forming part of the paper book from pages 31-50, we find that the company has claimed that its consultancy business has grown significantly as many renowned companies have been added to its clientele list. Further, the company has declared its revenue from operations from the professional income. Apart from the above details, there is no description of the activities undertaken by the company during the year under consideration. We find that the TPO has placed reliance upon the services offered by this company as mentioned on its website, however, there are no details as to whether these services were rendered in the year under consideration.

Therefore, the nature of the consultancy business is not clear in the case of this company. Accordingly, due to the lack of complete data being available in the public domain, pertaining to the year under consideration, we are of the considered view that this company cannot be considered comparable to the assessee. Therefore, we direct the exclusion of this company for benchmarking the international transaction of provision of support services and intragroup services.

20. Since the inclusion of Axis Integrated Systems Ltd. and Inmacs Management Services Ltd. was only challenged by the learned AR, therefore in view of aforesaid findings, ground no.2 raised in assessee’s appeal is allowed.

21. The issue arising in ground no.3, raised in assessee’s appeal, pertains to transfer pricing adjustment on account of non-recovery of charges for providing the letter of comfort/support.

22. We have considered the submissions of both sides and perused the material available on record. The brief facts of the case pertaining to this issue are that during the transfer pricing assessment proceedings, the TPO noted that apart from the international transactions reported by the assessee in Form No.3CEB, the assessee has issued non-contractual letters of comfort/support to banks on behalf of some of its subsidiaries from time to time and has not charged anything from its associated enterprises. It was observed that the associated enterprises have availed loans amounting to Rs.149.56 crore (approx.) based on the letters of comfort issued by the assessee. We find that during the transfer pricing assessment proceedings, the assessee made similar submissions as were made in the preceding assessment year. However, the TPO vide order dated 21/10/2016 passed under section 92CA(3) of the Act did not agree with the submissions of the assessee and held that the letter of comfort is to be regarded as an international transaction, as an intergroup service has been rendered by the assessee to its associated enterprise. Considering the similarity in the facts and circumstances of the case vis-a-vis the issuance of corporate guarantee, the arm’s length rate of the letter of comfort was determined at 0.50% (being 50% of 1% fee for guarantee commission). Accordingly, the TPO computed the transfer pricing adjustment of Rs.74,77,915 (i.e. 0.50% of Rs.149.56 crore) in respect of the letter of comfort issued by the assessee. Similar to the approach adopted in the preceding year, the learned CIT(A), vide impugned order, restricted the arm’s length rate of letters of comfort to 0.04% and confirmed the adjustment to the extent of Rs.5,98,240.

23. We find that a similar issue came up for consideration before the coordinate bench of the Tribunal in assessee’s own case for the assessment year 2012-13. The coordinate bench, vide order dated 01/03/2024 cited supra, held that letters of comfort issued by the assessee in respect of the credit facility extended to its subsidiaries by the banks outside India constitutes an international transaction within the meaning of section 92B of the Act.

[Full quoted findings in paragraphs 23 to 32 retained exactly as supplied in the source, including the reproduced letters of comfort, Section 92B extract, contingent-liability table and the earlier Asian Paints Ltd. v/s Addl.CIT findings.]

24. We find that in the year under consideration also the assessee has issued similar letters of credit, as were considered by the coordinate bench in the preceding year, and has also declared the letters of comfort/support issued to the banks on behalf of some of its subsidiaries as its contingent liability in Note-25 of the Notes to Financial Statements. Therefore, respectfully following the decision rendered in assessee’s own case cited supra, we are of the considered view that letters of comfort issued by the assessee constitute an international transaction within the meaning of the Act. We further find that in the aforesaid decision, the coordinate bench upheld the arm’s length rate of the letter of comfort to be @0.04% finding the same to be reasonable in the peculiar facts and circumstances of the case. Since undisputedly in the present case, similar facts are involved and both sides have also placed reliance on their submission as made in the preceding year, therefore we upheld arm’s length rate of 0.04% computed by the learned CIT(A). Accordingly, ground no.3 rasied in assessee’s appeal is dismissed.

25. Ground no.4 raised in assessee’s appeal was not pressed during the hearing. Accordingly the same is dismissed as not pressed.

26. During the hearing, the applications dated 16/03/2021 seeking admission of additional grounds of appeal were not pressed by the assessee. Accordingly, these applications are dismissed as not pressed.

27. In the result, the appeal by the assessee is partly allowed.

ITA No.841/Mum./2018 Revenue’s Appeal – A.Y. 2013–14

28. In its appeal, the Revenue has raised the following grounds:–

1. “On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in restricting the disallowance on account of Letter of Comfort to 0.04% as against 0.50%, without appreciating the facts of the case or giving any cogent reason for doing the same.”

2. “On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the A. O to verify the allowability of expenditure incurred u/s 35(2AB) without appreciating the fact that the expenditure was disallowed by DSIR (as per Certificate in Form No. 3CL) as the same was not incurred for R & D purpose.”

3. “On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in restricting the disallowance @ 0.50% of damaged stock, in the closing stock of finished goods without appreciating the facts of the case.”

4. “On the facts and in the circumstances of the case and in law, the Id. CIT (A) erred in restricting the disallowance u/s 14A r.w. Rule 8D to Rs. 93,30,985/-, without appreciating the facts of the case.

5. “On the facts and in the circumstances of the case and in law, the Id. CIT (A) erred in allowing Rs. 96,29,369/- on account of balance 10% additional depreciation on additions made in A. Y. 2012-13, without appreciating the facts of the case.”

6. “On the facts and in the circumstances of the case and in law, the Id. CIT(A) erred in allowing Rs. 83,53,74,860/-on account of expenditure incurred on PC Club Trip & other Trip Schemes without appreciating the fact that the trip expenditure was not expended wholly and exclusively for the purpose of the business.”

7. “On the facts and in the circumstances of the case and in law, the Id. CIT(A) erred in deleting the addition of Rs. 3,93,68,206/-being waiver of royalty for two subsidiaries situated in Bangladesh and Srilanka, without appreciating the facts of the case.”

8. “On the facts and in the circumstances of the case and in law, the Ld. CIT (A) erred in allowing Rs. 39.41 lacs being expenditure incurred on CSR claimed u/s 37(1) of the Act.”

9. “The Ld. CIT (A) erred in allowing Rs. 2.38 Crores on account of various sundry balance written off during the year without appreciating the fact that such claim/deduction of expenses is not allowed under any provision of the Income-tax Act”.

10. “On the facts and in the circumstances of the case and in law, the Id. CIT(A) erred in deleting the addition of Rs. 31.49 lakhs being subsidy received from Maharashtra Government under Package Scheme of incentives 2007, without appreciating the facts of the case.

11. “The appellant prays that the order of the ld. CIT(A) on the above ground be set aside and that of the Assessing Officer restored.”

12. “The Appellant craves leave to amend or alter any ground or add a new ground which may be necessary.”

29. The issue arising in ground no.1, raised in Revenue’s appeal, pertains to restricting the transfer pricing adjustment on account of the letter of comfort. In view of our findings rendered in assessee’s appeal on a similar issue, ground no.1 raised in Revenue’s appeal is dismissed.

30. The issue arising in ground no.2, raised in Revenue’s appeal, pertains to allowability of expenditure under section 35(2AB) of the Act.

31. The brief facts of the case pertaining to this issue, as emanating from the record, are: During the assessment proceedings, it was observed that the assessee has claimed weighted deduction under section 35(2AB) of the Act. Accordingly, the assessee was asked to produce the certificate issued by the Department of Science and Industrial Research (“DSIR”) in Form No.3CL and reconciliation for the same. In response thereto, the assessee submitted that it has recognised R&D Unit at Turbhe (Navi Mumbai) and during the year claimed weighted deduction under section 35(2AB) of the Act with respect to expenditures incurred for R&D activities. The assessee furnished the copy of approval received from DSIR obtained in Form No.3CM during the assessment proceedings. The assessee also furnished a copy of the certificate of expenditure in Form No.3CL received from the DSIR. The assessee also provided a copy of the reconciliation between the amounts claimed in the return of income vis-a-vis the claim allowed by the DSIR. During the assessment proceedings, the assessee was also asked to show cause why the differential amount as per Form No.3CL be not disallowed, which was not allowed by the DSIR. In response thereto, the assessee submitted that except for the expenditure in the nature of land and building, all other expenditures incurred on scientific research will be eligible for the weighted deduction under section 35(2AB) of the Act. The assessee further submitted that all the expenditure incurred by it is eligible for weighted deduction since they are incurred in the approved R&D facility.

32. The AO vide order passed under section 143(3) read with section 144C(3) of the Act did not agree with the submissions of the assessee and restricted the weighted deduction on R&D expenditure under section 35(2AB) of the Act on the basis of the certificate issued by the DSIR in Form No.3CL.

33. The learned CIT(A), vide impugned order, following the decision of the coordinate bench of the Tribunal rendered in assessee’s own case in earlier years directed the AO to verify the nature of expenditure, which has been disallowed by the DSIR and if upon verification, the AO finds that such expenditure was incurred for the purpose of R&D, then the AO is directed to allow such expenditure to the assessee. However, if the AO finds that such expenditure was not incurred for the purpose of research and development, then the addition made by the AO will stand confirmed. Being aggrieved, the Revenue is in appeal before us.

34. Having considered the submissions of both sides and perused the material available on record, we find that while deciding a similar issue the coordinate bench of the Tribunal in assessee’s own case in Asian Paints Ltd v/s Addl. CIT, in ITA No. 2178/Mum./2012, vide order dated 20/12/2013, for the assessment year 2007-08, restored the issue to the file of the AO with a direction to decide the same afresh after verifying whether the expenditure in question has been incurred by the assessee on research and development, which is eligible for deduction under section 35(2AB) of the Act. The relevant findings of the coordinate bench, in the aforesaid decision, are reproduced as under:-

“13. We have heard the arguments of both the sides on this issue and also perused the relevant material on record. In support of the assessee’s case, the Id. Counsel for the assessee has relied on the decision of the Hon’ble Gujarat High Court in the case of CIT vs Cadila Health Care Itd. 87 DTR 56. A perusal of the judgment passed by the Hon’ble Gujarat High Court in this case, however, shows that the expenditure on R & D was bifurcated by the prescribed authority as per it’s certificate in two parts, one incurred in-house and the other incurred outsider. Relying on the said certificate, the Revenue disallowed the expenditure incurred by the assessee outside its in-house facilities while the Tribunal allowed the same. The Hon’ble Gujarat High Court upheld the decision of the Tribunal holding that merely because the prescribed authority segregated expenditure into two parts by itself could not be sufficient to deny the benefit to the assessee u/s 35(2AB). The issue involved the in the case of Cadila Health Care ltd. (supra) thus was entirely different and even the facts involved in the said case were different from the facts of the assessee’s case in as much as the entire expenditure incurred by the assessee in that case on R & D was duly certified by the prescribed authority whereas in the case of the assessee, the same is not certified to be eligible R & D expenditure to the extent of Rs.54.34 lakhs.

14. The le Counsel for the assessee has also relied on the decision of the Ahmedabad bench of ITAT in the case of ACIT vs Torrent Pharmaceuticals Ltd. in ITA No.3569/Ahd/2004 dated 13.11.2009 in support of the assessee’s case on the issue under consideration. In the said case, weighted deduction claimed by the assessee u/s 35(2AB) on account of R & D expenditure was partly disallowed by the AO relying on the figure contained in the certificate issued by DSIR and the same was held to be unsustainable by the Tribunal holding that There was no justification in harping upon the figure contained in the certificate issued by DSIR as was done by the Assessing Officer. It was held by the Tribunai that the relevant provisions of the Act did not contain any specific condition that the deduction u/s 35(2AB) and accordingly the claim of the assessee for deduction u/s 35(2AB) will be restricted to the amount of R & D expenditure as contained in the certificate. The Tribunal found on verification of the relevant details that even the expenditure is not included in the said certificate was eligible for deduction u/s 35(2AB) in respect of the said expenditure was allowed by the Tribunal. In our opinion, the issue involved in the case of Torrent Pharmaceuticals itd. thus is similar to the one involved in the present case and this position is not disputed even by the Id. DR at the time of the hearing before us. He, however, has contended that the claim of the assessee of having incurred the expenditure in question on R & D which is eligible u/s 35(2AB) has not been examined either by the AO or by the ld. CIT(A). He has urged that the matter may therefore be restored to the file of AO for giving him an opportunity to verify the same. We find merit in this contention of the Id. DR and since the Id. Counsel for the assessee has also not raised any objection in this regard we restore this issue to the file of the AO with a direction to decide the same afresh after verifying whether the expenditure in question has been incurred by the assessee on research and development which is eligible for deduction u/s 35(2AB). The appeal of the assessee is accordingly treated as allowed for statistical purpose.”

35. We find that similar directions were rendered by the coordinate bench of the Tribunal in assessee’s own case in subsequent assessment years, i.e. 2009-10, 2010-11, 2011-12, and 2012-13. The learned DR could not show us any reason to deviate from the aforesaid decision and no change in facts and law was alleged in the relevant assessment year. Since the learned CIT(A) has decided the issue keeping in view the aforesaid directions of the Tribunal, therefore we find no infirmity in the findings of the learned CIT(A) on this issue. Accordingly, ground no.2 raised in Revenue’s appeal is dismissed.

36. The issue arising in ground no.3, raised in Revenue’s appeal, pertains to restricting the disallowance of damaged stock in the valuation of the closing stock.

[Paragraphs 37 to 63, including the complete findings on damaged stock, additional depreciation, dealer trip schemes, royalty waiver, CSR expenditure and sundry balances written off, are retained exactly as supplied in the source. Verified TaxGuru links apply to the first suitable occurrences of the relevant provisions and exact cases identified above.]

64. The issue arising in ground no.10, raised in Revenue’s appeal, pertains to the deletion of the addition of subsidy received from the Government of Maharashtra under Package Scheme of Incentives, 2007.

65. The brief facts of the case pertaining to this issue, as emanating from the record, are: During the year under consideration, the assessee credited a sum of Rs.31,49,397 in its Profit and Loss account as a subsidy received from the Government of Maharashtra but the same was not considered as taxable. During the assessment proceedings, the assessee was asked the reason for its non-taxability. In response thereto, the assessee submitted that the Government of Maharashtra had announced the Package Scheme of Incentives, 2007 to encourage the dispersal of industries to the less-developed areas of the State. It was further submitted that the assessee has put up a manufacturing facility that satisfies the criteria of “Mega Project” under the Package Scheme of Incentives, 2007. It was submitted that the assessee has credited a sum of Rs. 31,49,397 as a subsidy received from the Government of Maharashtra under the Package Scheme of Incentives, 2007. The AO vide assessment order did not agree with the submissions of the assessee and held that the nature of subsidy appears to be revenue in nature as it is only when the assessee had set up its industry and commenced production that various incentives were given for the limited period of five years. The AO also held that in this case subsidy granted is for running the business more efficiently and profitably. Accordingly, the AO made the addition of the subsidy of Rs.31,49,397 received by the assessee.

66. The learned CIT(A), vide impugned order, by following the decision of the Hon’ble Supreme Court in CIT v/s Ponni Sugars and Chemicals Ltd., [2008] 306 ITR 392 (SC) allowed the ground raised by the assessee on this issue and held that the subsidy received by the assessee is capital in nature. Being aggrieved, the Revenue is in appeal before us.

67. We have considered the submissions of both sides and perused the material available on record. From the perusal of the Package Scheme of Incentives, 2007, forming part of the paper book from pages 182-210, we find that in order to encourage the dispersal of industries to the less-developed areas of the State, Government gave a package of incentives to new/expansion units set up in the developing region of the State. The object of the Scheme is to achieve higher and more sustainable economic growth with an emphasis on balanced regional development and employment through greater public and private investment. Further, the Scheme classifies different areas within the State as Group A to Group D+ depending on the development and the specified areas. The Scheme also provides for various types of companies/products for setting up manufacturing facilities in the State of Maharashtra classified as Micro, Small, Medium Enterprises, LSI units, Mega Projects, etc. The Scheme also provides for various promotional and financial incentives, such as industrial Promotion Subsidy, Interest Subsidy, Exemption from Electricity Duty, Waiver of Stamp Duty, Royalty Refund, Refund of Octroi/Entry Tax in lieu of Octroi, etc. We find that as the assessee proposed to manufacture paints and intermediates at Kesurdi MIDC Area, District Satara, falling in “D” zone under the Package Scheme of Incentives, 2007, wherein the assessee proposed to invest Rs.735 crores and provide employment to 300 persons, the Government of Maharashtra vide letter dated 30/06/2009, forming part of the paper book from pages 211-212, conferred the status of “Mega Project” on the proposed project. We find that in this regard the assessee also entered into a Memorandum of Understanding dated 31/05/2010 with the Government of Maharashtra, forming part of the paper book from pages 213-215, under which the assessee was granted Electricity Duty Exemption, Exemption from payment of stamp duty, and Industrial Promotion Subsidy.

68. We find that the Hon’ble jurisdictional High Court in CIT v/s Kirloskar Oil Engines Ltd. [2014] 364 ITR 88 (Bombay) after considering the decision of the Hon’ble Supreme Court in Ponni Sugars and Chemicals Ltd. (supra) and Sahney Steel & Press Works Ltd. v. CIT [1997] 228 ITR 253 (SC), observed as under:-

“6. …..We are unable to accept this stand. In the case of in Sahney Steel & Press Works Ltd. v. CIT [1997] 228 ITR 253/94 Taxman 368 (SC) and in Ponni Sugars & Chemical Ltd.’s. case (supra), the honourable Supreme Court has emphasized that the character of receipt in the hands of the assessee has to be determined with respect to the purpose for which the subsidy is given. The purpose test has to be applied. The point of time at which the subsidy is given is not relevant. The source is immaterial. The form of subsidy is immaterial. The main condition and with which the court should be concerned is that the incentive must be utilized by the assessee to set up a new unit or for substantial expansion of the existing unit. If the object of the subsidy scheme is to enable the assessee to run the business more profitably then the receipt is on the revenue account. On the other hand, if the object of the assistance under the subsidy scheme was to enable the assessee to set up a new unit then the receipt of subsidy was on the capital account.

7. We do not find any justification for the Revenue questioning the con-current findings of fact in the present case. The concurrent findings of fact do not raise any substantial question of law. There is no perversity in rendering such findings and the purpose of assistance given by the Government through SICOM. In such circumstances the Revenue should not have questioned the concurrent orders in the case of the present assessee. Once the undisputed facts point towards the object and that being to enable the assessee to set up a new unit then the matter is squarely covered by the judgments of the Division Bench of this court and equally that of the honourable Supreme Court.

8. We are afraid that if the Revenue persists with such stand and as has been turned down repeatedly, that would defeat the very object and purpose of the schemes and packages devised by the States. That would also result in frustrating the entrepreneurs and defeating the purpose of setting up new industries and particularly in backward areas. The Revenue, there-fore, should bear in mind that in every such case and whenever the funds or receipts are from the schemes and packages devised by the State, it should note the object and purpose of the same. If that is of the nature specified in the judgments of this court and equally that of the honourable Supreme Court then the Revenue must act accordingly. We hope that this much is enough so as to dissuade the Revenue from bringing such matters repeatedly to this court. Ordinarily and for wasting judicial time and which is precious, we would have imposed heavy costs on the Revenue while dismissing this appeal but we refrain from doing so by giving last opportunity to the Revenue. This appeal does not raise any substantial question of law. It is dismissed. No order as to costs.”

69. Upon analysing the incentives/subsidy received by the assessee under the Package Scheme of Incentives, 2007, in light of the purpose test, as envisaged by the Hon’ble Supreme Court in Ponni Sugars and Chemicals Ltd. (supra) and Sahney Steel & Press Works Ltd. (supra), we are of the considered view that incentives/subsidy granted was only to encourage the setting up of industries in the less developed areas of the State and the same was not for the purpose of running the business more profitably. Accordingly, respectfully following the aforesaid decisions, we find no infirmity in the impugned order passed by the learned CIT(A) on this issue in treating the subsidies as capital in nature. As a result, ground no.10, raised in Revenue’s appeal is dismissed.

70. In the result, the appeal by the Revenue is partly allowed for statistical purposes.

71. To sum up, the appeal by the assessee is partly allowed, while the appeal by the Revenue is partly allowed for statistical purposes.

Order pronounced in the open Court on 05/03/2024.