Penalty cannot be levied in respect of an addition not having been made in quantum assessment

In this Question arose for consideration was whether penalty under section 271(1)(c) of Income Tax Act, 1961 could be levied in respect of an addition not having been made in quantum/assessment proceedings and it was held that Imposition of penalty proceedings under section 271(1)(c) is strictly circumscribed to addition which has been made/confirmed in the assessment/quantum proceedings. Hence, addition not having been made in the assessment or in quantum proceedings by any appellate authority, could not be roped in penalty proceedings either by AO or CIT(A) in terms of power enshrined under section 251.

ORDER

Amit Shukla, J.M.

The aforesaid appeal has been filed by the assessee against impugned order dated 18-3-2014, passed by the learned Commissioner (Appeals), Noida, in relation to penalty proceedings under section 271(1)(c). In the grounds of appeal assessee has raised following grounds :–

‘1. That having regard to the facts and circumstances of the case, learned Commissioner (Appeals) has erred in law and on facts in confirming the action of learned assessing officer in levying penalty of Rs. 23,20,000 under section 271(l)(c) being illegal and void-ab-initio.

2. That in any case and in any view of the matter, action of learned Commissioner (Appeals) in confirming the action of learned assessing officer in levying the penalty of Rs. 23,20,000 under section 271(l)(c) is bad in law and against the facts and circumstances of the case.

3. That having regard to the facts and circumstances of the case, learned Commissioner (Appeals) has erred in law and on facts in confirming the action of learned assessing officer in levying penalty under section 271(l)(c) on the following additions made in assessment order and more so when framing the such assessment order under section 143(3)/144C dated 28-2-2011 is also contrary to law and facts.

On account of expenses of capital nature–Rs. 5,00,000

On account of transfer price adjustment–Rs. 63,85,158

4. That having regard to the facts and circumstances of the case, learned Commissioner (Appeals) has erred in law and on facts in confirming the action of learned assessing officer in levying penalty under section 271(l)(c) which is bad in law being beyond jurisdiction and barred by limitation and contrary to the principles of natural justice and has been passed by recording incorrect facts and findings and without giving adequate opportunity to the assessee and the same is not sustainable on various legal and factual grounds.

5. That having regard to the facts and circumstances of the case, learned Commissioner (Appeals) has erred in law and on facts in confirming the action of learned assessing officer in imposing a penalty of Rs. 20,79,453 that too without recording mandatory “satisfaction” as per law.

6. That having regard to the facts and circumstances of the case, learned Commissioner (Appeals) has erred in law and on facts in directing the assessing officer to revise/enhancing the quantum of penalty with respect to TP adjustment of Rs. 60,23,024 on account of raw material import and that too by recording incorrect facts and finding and by disregarding the principles of natural justice and without bringing anything contrary on record.

7. That the assessee craves the leave to add, alter or amend the grounds of appeal at any stage and all the grounds are without prejudice to each other.’

2. Here in this case, the assessing officer had levied penalty of Rs. 23,20,000 on an addition aggregating to Rs. 68,85,158, which was made on account of:-firstly, transfer pricing adjustment of Rs. 63,85,158 in respect of purchase/import of capital goods from AE; and secondly, disallowance of Rs. 5,00,000 paid as ROC fees for increase in authorized capital which has been treated as capital expenditure by the assessing officer. However, the learned Commissioner (Appeals) has enhanced the penalty on further addition of Rs. 60,23,024 which was on account of transfer pricing adjustment in respect of purchase/import of raw materials from AE, though proposed by TPO, but not made by the assessing officer.

3. The brief facts of the case qua the issue involved are that, the assessee company was engaged in the business of manufacturing of auto parts especially for interiors. It is subsidiary of M/s. Summit Auto Seats Industry Company Ltd. (SAS) Thailand, which held 82.50% of its share capital. In the quantum proceedings, the learned TPO to whom the matter was referred by the assessing officer to determine the arm’s length of the international transactions entered with the assessee with SAS during the relevant assessment year had proposed certain adjustments to be made in arm’s length price of the transactions. During the year under consideration as stated by the assessee in its T.P. study report, it has undertaken following international transactions :–

4. For computing its arm’s length price of aforesaid international transactions, the assessee had adopted “Cost Plus Method” (CPM) and submitted that the AE charges the assessee company with markup of 10% of the total cost of purchase of the raw materials and capital goods, which meets the ALP requirement. The learned TPO noted that the assessee while adopting CPM as MAM has not bench marked its ALP by carrying out any comparability analysis after identifying independent comparable. Therefore, in absence of assessee’s failure to furnish suitable comparables, the learned TPO held that CPM cannot be adopted as most appropriate method and held that TNMM should be taken as MAM for bench marking the ALP of the transaction. Since the assessee was incurring huge loses and sales have been made entirely to the AE, the TPO held that “tested party” should be foreign AE. After going through AE’s financials, he noted that the operating margin of the AE has been stated to be 8.62% which has been worked out in the following manner :–

The learned TPO further observed that the AE has failed to take into account the “other income” of 44.10 Crore Thai Bhat (on the ground that details were not known), which according to him should be part of operating income and therefore, to be added to the operating profit. Accordingly, he determined the operating profits/sales at 14.73% in the following manner :–

In this manner he has enhanced the operating margin of the ‘tested party’ (i.e., AE) at 14.73%, instead of 8.72% declared by the said AE in its financials.

5. Thereafter learned TPO held that, since no comparative information regarding normal profit markup of AE is available, therefore, he chose to undertake the search process of the comparables on the Indian Prowess Data of the local Indian companies and after identifying 7 comparable companies, the arithmetic mean of whom where arrived at 5.94%, he held that same is to be treated as the actual margin of the A.E for determining the ALP. The lists of the comparables with their profit margin are as under :–

After taking into account the enhanced operating margin of the A.E. vis-à-vis the average margin of comparables, (i.e.,14.73% – 5.94% =8.79%), TPO held that A.E. has earned excessive margin of 8.79% on the total sales made to the assessee. Thereafter, he computed the ALP of international transactions of purchase of raw materials in the following manner :–

6. As regards the computation of ALP in respect of purchase of capital goods, he made the ALP adjustment in the following manner :–

7. The aforesaid transfer pricing adjustment was proposed by the TPO to the assessing officer, however the learned assessing officer in his order, had made addition in respect of ALP adjustment on import/purchase of capital goods and did not made any adjustment in respect of import/purchase of raw materials by the assessee. Apart from the one TP adjustment, the learned assessing officer has further added a sum of Rs. 5 lakhs which has been disallowed by him as capital expenditure on the ground that such an expense has been incurred towards filing fees to ROC on enhanced capital. Some further additions like disallowance on personal user of vehicles and telephone expenses were also made, which are not the subject matter of penalty, before us. Accordingly, the addition on which penalty was initiated and levied by the assessing officer was only in respect of TP adjustment of Rs. 63,85,138 and Rs. 5,00,000, disallowed as capital expenditure. Against the said assessment order, the assessee did not prefer any appeal before the learned Commissioner (Appeals). In this manner, the additions made by the assessing officer in the assessment order had attained finality.

8. In the course of the penalty proceedings under section 271(1)(c) initiated by the assessing officer in terms of the said assessment order, the assessing officer noted that as against the ‘nil’ income declared by the assessee, the assessment was completed at Rs. 69,76,510 after making the following additions :–

(i) Addition on a/c of personal use of vehicles :– Rs. 41,848

(ii) Addition on a/c of personal use of telephone :– Rs. 49,520

(iii) Addition on a/c of expenses of capital nature :– Rs. 5,00,000

(iv) Addition on a/c of transfer price adjustment :– Rs. 63,85,158

In the penalty proceedings, in response to the show cause notice, assessee made its elaborate submissions as to why penalty cannot be levied on such additions, however the learned assessing officer has rejected the assessee’s contention and levied the penalty at Rs. 23,20,000 after observing and holding as under :–

“On the facts of the case as discussed above, it is held that assessee has furnished inaccurate particulars of income and thereby concealed true particulars of such income to the extent of Rs. 68,85,158 and is liable for penalty under section 271 (1)(c) of the Act. The minimum and maximum penalty in respect of which the inaccurate particulars of income have been furnished comes to Rs. 23,17,545 being 100% and Rs. 69,52,635 being 300% respectively. Considering the facts and circumstances of the case, I hereby impose penalty of Rs. 23,20,000 under section 271(1)(c) of the Act and direct the assessee to pay the same.”

9. However the learned Commissioner (Appeals) apart from confirming the penalty on the additions made by the assessing officer in the assessment order has further enhanced the penalty in respect of transfer pricing adjustment on the import/purchase of raw material of Rs. 60,23,024 which was originally proposed by the TPO, but omitted to be added by the assessing officer. Such an enhancement has been made by the learned Commissioner  (Appeals) despite the fact that in the quantum proceedings the additions made by the assessing officer had attained finality, as neither any first appeal was filed by the assessee nor such an assessment order has been disturbed either under the revisionary jurisdiction under section 263; nor under section 148; and nor under section 154. Thus from the stage of the learned Commissioner (Appeals), not only the quantum of penalty has been confirmed which was levied by the assessing officer but it has also been enhanced on an amount of addition which was not made in the assessment order.

10. Before us the learned Counsel, Dr. Rakesh Gupta after explaining the entire facts submitted that learned Commissioner (Appeals) has exceeded his appellate jurisdiction by levying the penalty on an addition which has not been made in the quantum proceedings. He can only levy or enhance the penalty only to the extent of additions which has been made in the quantum proceedings. Thus, penalty enhanced by the learned Commissioner (Appeals) here in this case is without jurisdiction and same should be deleted.

11. As regards the levy of penalty on account of transfer pricing adjustment in respect of import/purchase of capital goods, he submitted that first of all, the learned TPO could not have increase the operating profit of the A.E. by considering the element of “other income” as part of operating sales, because the “other income” mostly consists of dividend income which has nothing to do with the sales. Therefore, such an increase of PLI as made by the TPO is unjustified in law and on facts. If the profit margin of 8.62% of the A.E. is taking into consideration and the arithmetic mean of comparable are taken at 5.49%, then such a margin will fall within the range of plus/minus 5% and in that situation no TP adjustment could have been made. In any case, it cannot be said that there is any case of furnishing of any inaccurate particulars of income. He further submitted that the assessing officer in the assessment order has initiated the penalty proceedings on both the charges, one for furnishing of inaccurate particulars and also for concealment of income. In the penalty proceedings the assessing officer has again levied the penalty on both the counts without specifying the charge. The learned Commissioner (Appeals) too has confirmed the penalty under both the charges which cannot be sustained in law, because, the charge for initiating the penalty proceedings and levy under section 271(1)(c) should be very specific. In support, he relied upon the decision of Karnataka High Court in the cases ofCIT v. Manjunatha Cotton & Ginning Factory (2013) 359 ITR 565;New Sorathia Engg. Co. v. CIT (2006) 282 ITR 642 (Guj.). Apart from that, he submitted that the assessee has been incurring huge loses and there could not have been any benefit for evading any tax and therefore, in such circumstances also penalty cannot be confirmed. In support of this proposition also he has filed certain Tribunal decisions before us.

12. Regarding the addition of Rs. 5 lakhs fee paid to ROC, he submitted that the same was paid for increase of authorized capital which is not for any enduring benefit accrued to the assessee and it was claimed as revenue expenses, which has been charged to the profit of loss account. In any case all the particulars and facts in this regard were disclosed in the books of accounts and therefore, there cannot be a case for furnishing of inaccurate particulars. In support, he relied upon the decision of Hon’ble High Court of Delhi in case ofCIT v. A & T Communication Services (2012) 342 ITR 257, wherein on similar issue it was held that whether it is a capital or revenue is highly debatable issue on such debatable issue penalty cannot be levied.

13. On the other hand, the learned. Sr. CIT DR submitted that there was a clear cut adjustment proposed by the TPO in respect of import of raw materials and import of capital goods. The assessing officer by mistake had taken only one item the TP adjustment and omitted to make an addition in respect of import of raw material which was proposed at Rs. 60,23,024. Since assessee had not preferred any appeal in the quantum proceedings, therefore, the learned Commissioner (Appeals) in the penalty proceedings took note of this fact and also gave opportunity to the assessee as to why the penalty should not be levied on such an amount of addition. This addition was inadvertently left to be made by the assessing officer by mistake or through oversight, therefore, it has to be factored in for the purpose of penalty proceedings. Thus, the learned Commissioner (Appeals) is well within his power to levy penalty on such additions. He further submitted that the assessee is taking a new legal plea before this Tribunal by contesting that the learned Commissioner (Appeals) could not have made such an enhancement in penalty proceedings and therefore, either such a plea should not be entertained or the matter should be restored back to the file of the learned Commissioner (Appeals). On the merits as regards the TP adjustment on account of import/purchase of capital goods, he submitted that the TPO has categorically rejected the CPM method adopted by the assessee for the reason that the assessee has not bench marked with any comparables and in absence of any comparability analysis with uncontrolled transactions, the bench marking analysis done by the assessee for determining his ALP is faulty and incorrect in law. Since under the CPM, assessee’s ALP could not be determined, therefore, TPO was forced to adopt TNMM as most appropriate method and after carrying out the proper comparability analysis he has arrived at arithmetic mean of 5.94% and thereafter, he has made the adjustment in accordance with the law. As regards the element of “other income” as a part of operating profit, he submitted that the overall income has to be taken into consideration for determining the PLI. Thus, he strongly relied upon the order of the learned Commissioner (Appeals).

14. In rejoinder the learned counsel submitted that the assessee has taken a specific ground before this Tribunal challenging the validity of the enhancement of the learned Commissioner (Appeals) and after passing of the order of the learned Commissioner (Appeals), only forum in which the assessee can raise this issue is before this Tribunal. Apart from that, he pointed out from the order of the learned Commissioner (Appeals) that this issue was specifically raised before the learned Commissioner (Appeals). Thus, he could not have made any enhancement of penalty on the addition which has not been made by the assessing officer.

15. We have heard the rival submissions and perused the relevant findings given in the impugned order as well as the material placed before us. We will first address the issue of enhancement of penalty made by the learned Commissioner (Appeals) on an addition which has not been made in the quantum proceedings. As discussed above, the learned TPO has proposed two TP adjustment; first, for sum of Rs. 63,85,158 on account of import/purchase of capital goods from the A.E.; and secondly, for Rs. 60,23,024 in respect of import/purchase of raw materials. However, the learned assessing officer in his assessment order passed under section 143(3)/144C has made addition on account of TP adjustment of Rs. 63,85,158 only which was in respect of import/purchase of capital goods. He did not make any addition in respect of other TP adjustment. Now such an assessment/addition has attained finality as it has not been revised or rectified under section 263 or under section 154 or has been reopened under section 147/148. Once the addition has been made/confirmed in the quantum proceedings, then subject matter of penalty proceedings under section 271(1)(c) is strictly circumscribed to such addition only. The penalty cannot be levied on an addition which has not been made in the assessment or in quantum proceedings by any appellate authority and hence if no such addition has been made in assessment, then same cannot be roped in penalty proceedings either by the assessing officer or by learned Commissioner (Appeals) in terms of power enshrined under section 251. Here the learned Commissioner (Appeals) is absolutely unjustified in law and on facts to levy or enhance a penalty on an addition which is not arising out of assessment order or any appellate order in the quantum proceedings or from the penalty order passed by the assessing officer. Once the assessee had raised this issue before the learned Commissioner (Appeals), then the learned Commissioner (Appeals) should have given his elaborate reasons and justifications under the law as to how he can proceed to levy a penalty which was never a subject matter of addition by the assessing officer. If there was anybona fide mistake or omission of not making the addition, that mistake could only be rectified in the assessment proceedings or appellate proceedings in the quantum side or under any other provisions of the Act like, under section 263 or under section 148 or under section 154. It has not been brought on record that assessing officer has rectified his mistake and has revised his assessment and demand by taking into account the aforesaid adjustment. In absence of such rectification or revision of the assessment order, we are of the opinion that the penalty levied under section 271(1)(c) on addition of Rs. 60,23,024 as done by the learned Commissioner (Appeals), is beyond his jurisdiction and the same is directed to be quashed. As a passing remark we would like to add that, the Commissioner (Appeals) as a first appellate authority though has vast powers under section 251, but he should not transgress his jurisdiction or exercise power beyond the mandate of law and if any such action is being done then the same should be justified within the ambit of the law or by taking any support from any judicial precedence. Here no judicial precedence or any statutory provision has been brought to our notice that, learned Commissioner (Appeals) can levy or enhance penalty under section 271(1)(c) whence there is no addition in the quantum/assessment proceedings. Accordingly, we hold that penalty on addition of Rs. 60,23,024 cannot be levied and the same is directed to be deleted.

16. Now coming to the levy of penalty of transfer pricing adjustment of Rs. 63,85,154 as discussed in the earlier part of order, the same has been made in respect of purchase/import of capital goods by the assessee from its A.E. From the perusal of the TPO’s order it is seen that he has rejected CPM method of the assessee on the ground that there is no proper bench marking exercise done by the assessee by comparing it from uncontrolled transaction with the third parties. Though such an observation of the learned TPO may be correct, but the manner in which he has proceeded to take A.E. (SAS Thailand) as “Tested Party” and then selecting the local comparables on Indian Data System to bench mark the margin of the A.E. which is a foreign entity cannot be appreciated or upheld at all. If A.E. has taken as “Tested Party”, then market and economic factors in which A.E. is operating has to be taken into consideration for bench marking any kind of profit margin of the said A.E for the purpose of determining the ALP and not the comparables which are working under Indian economic and market conditions. The TPO cannot made foreign A.E. as a ‘tested party’ and compare it with the Indian comparables who are operating under different geographical, economical and market environment. Such an exercise by the TPO vitiates the entire exercise of determining the ALP of the transaction and transfer pricing adjustment made by him. Apart from that, it is also noted that the sales of the A.E. constitutes its manufacturing of auto parts and for this purpose it imports raw materials and capital goods which is part of its direct operating cost. In such circumstances, the operating profit is to be based on income derived from sales and direct costs incurred on such sales of goods. Other incomes like ”dividend income’ cannot be reckoned as part of operating sales or operating profits. In this manner the tinkering of the PLI by including dividend income as part of operative income and operating profit by the TPO is again unjustified in law and facts. Thus, the PLI of 14.73% as determined by the TPO cannot be sustained on the facts of the present case. If the A.E. is operating profit is 8.62%, then in that case even if we take arithmetic profit margin of 5.92 % of the comparables which has been taken by the by the TPO, then such a margin will fall within the plus/minus range of 5%. On this count also, the transfer pricing assessment made by the TPO is unjustified in law and on facts. Thus, we hold that no penalty can be levied on such TP adjustment of Rs. 62,85,158 made on account of purchase/import of capital goods and accordingly, same is directed to be deleted.

17. So far as the levy of Rs. 5 lakhs, we find that the assessee’s case has been that it was on account of fee paid to ROC to increase the authorized capital which has been claimed as revenue. Nowhere from the records is it borne out that, whether such authorized capital was for either running of business or for any expansion of business or for setting up of new business. The treatment of such an expense whether it is for capital or revenue largely depends on the facts of the case and there is often very thin line demarcation between the expense which can be reckoned as capital or revenue. if the assessee had claimed to be a revenue expenditure stating that it the authorized capital was for the purpose of its running of business, then, it cannot be held that the assessee has filed any inaccurate particulars of income, if such an expense is treated as capital expenditure for the purpose of levy of penalty under section 271(1)(c). In any case whether the expenditure is revenue or capital is quite debatable issue and on such a claim, penalty under section 271(1)(c) for furnishing of inaccurate particulars cannot be levied. Thus, we hold that on this addition also no penalty can be levied by the assessing officer or can be confirmed by the learned Commissioner (Appeals) and therefore, same is directed to be deleted.

18. In the result, the appeal of the assessee is allowed.