Case Law Details
Brief of the Case
ITAT Mumbai held In the case of Greaves Cotton Ltd. vs. ITO that under the transfer pricing regulations, a comparability analysis is a comparison of a controlled transaction with uncontrolled transaction and they are comparable if none of the difference between transactions could effect the factors like price or margin. If there are some differences then a reasonable accurate adjustment can be made to eliminate the material effect of any such difference. In this case the TPO has carried out comparative analysis by adopting internal transactions with two AEs, which are completely controlled and related party transactions, hence, such a comparability analysis at the threshold is liable to be rejected.
Facts of the Case
The assessee is a Public Limited Company engaged in the business of manufacture and sale of marine and industrial gear boxes, diesel engines, generating sets, Tandem Rollers, Transit Mixture, Vibratory Compactors etc. and also trade in steam traps, pumps, fluid coupling and crucibles etc.
Disallowance u/s 14A
The assessee has earned following exempt income during the previous year; (a) dividend income of Rs. 28,56,000/- and (b) interest on tax free bonds of Rs. 21,000/- and Rs. 5,90,825/-. In response to the show cause notice as to why the expenditure attributable to earning of exempt income should not be disallowed, the assessee submitted that, firstly, the dividend received on shares were from the investment made in shares of Griever Morgwite Crucible Ltd., which was purchased long time back out of assessee’s own funds. Similarly, the investment in UTI Bonds and Kokan Railway Bonds were also made from assessee’s own funds. Hence, no expenditure can be said to have been incurred or can be attributed for the purpose of making these investments, especially no interest expenditure can be disallowed. The AO noted that similar submissions were made by the assessee during the course of assessment proceedings for the AYs 2001-02, 2002-03 & 2003-04, wherein 5% of the exempt income was treated as expenditure disallowable u/s 14A and accordingly, he made the disallowance of Rs. 1,73,364/- being 5% of the total exempt income of Rs. 34,67,285/- Besides this, he further made the disallowance of Demat charges of Rs. 8,25,010/- debited under the head “other sundry expenses” which was a direct expenditure. Accordingly, aggregate disallowance of Rs. 9,98,374/- was made.
Disallowance of professional fees
The assessee paid professional fees of Rs. 1,18,350/-, paid to ‘Majumdar and Co.’ for registration of copy rights of designs and engines which has been claimed as revenue expenditure by the assessee. The AO has treated the said expenditure to be capital in nature as the same is covered u/s 32.
Disallowance of various payments
The assessee made various payments including 1) Charges towards late payment fee to Chennai Municipal Corporation Rs. 9,650/- , Sales tax charged due to technical error and Stating destination of as Indore even though Consignee’s name and address were correctly Written on consignment Rs. 1,22,887/- , Compliance fee per Weights and Measurement Rules Rs. 32,000/- , Amount paid to High Court in pursuance of High Court order on company’s stay petition in respect Of appeal to HC Rs. 10,00,000/- . AO disallowed all the payment on the ground of infraction of law.
Disallowance of deduction of R & D expenses
The assessee has incurred capital expenditure of Rs. 6,48,912/- for the research of multipurpose light engine Units, which was claimed as deduction allowable u/s 35. Since assessee’s core product are engines, therefore, the assessee has to necessarily carry out research and development for developing efficient engines to stay in market and business. The assessee had decided to develop world class multipurpose engines and for this purpose it embarked upon “Avatar Project” and incurred expenses on technical expert advice, project materials and fees for Technical advisory services. The said project was to be completed in AY 2007-08 and sample products was also tested. Accordingly, the expenditure incurred on such a project was claimed as deduction u/s 35(1)(iv) r.w. sub-section (2)(ia). AO held that since the Auditors have mentioned “nil” amount against the deduction allowable u/s 35D, which means that nothing is qualified for deduction u/s 35.
Addition on account of transfer pricing adjustment
The assessee has undertaken transaction of import purchase of “kits and spares” from its two AEs namely, BOMAG GmbH, Germany (BOMAG) and CIFA Spa, Italy (CIFA) for sums amounting to Rs. 5,56,07,570/- and Rs.6,80,36,363/- respectively. For the purpose of benchmarking the arms length price on these international transaction, the assessee adopted ‘Resale Price Method’ (RPM) as the most appropriate method and has taken external comparables by adopting Profit Before Tax (PBT)/net sales. The assessee’s margin on such gross import was declared at 11.75% with BOMAG GmbH, 5.25% with CIFA the average of which was arrived at 8.53%. The gross margin of external comparables i.e. L & T Ltd., at 7.42% and Ingersoll India Rand Ltd. was 6.6%. Hence it was stated that, the assessee’s gross margin was much better and accordingly, it was submitted that the margin of import with AE was at arm’s length price.
However, the Ld. TPO observed that assessee is showing its transfer pricing result by adopting TNMM to justify the margins. He also rejected the external comparables selected by the assessee. He further observed that since assessee is carrying out transaction with 2 AEs, therefore, there is an internal comparability and if internal RPM is applied and gross margin of BOMAG GmbH, Germany which was at 11.7% and transaction with SIFA Spa, Italy, which was 5.28% is applied to benchmark the assessee’s margin, then it can be seen that there is huge variation and therefore adjustments has to be made. Thus, he held that 11.78% should be taken as arm’s length gross profit margin for benchmarking the margin with SIFA Spa, Italy. Accordingly, an adjustment of Rs. 1,23,86,407 was made on account of transaction with SIFA Spa, Italy.
Computation of long-term-capital-gain
The assessee has sold residential flats which were acquired prior to 5 years. As per the depreciation statement in the block of assets, residential building was shown at “nil”. Accordingly, the Assessing Officer treated gain on sale of these flats as short-term-capital-gain u/s 50. The assessee’s case before the authorities below was that since these flats were held for more than 5 years, hence held to be capital arising from sale of flats were long-term capital gain. It was submitted that fiction created in section 50 is only to restricted to mode of computation of capital gain contained in sections 48 & 49 and does not apply to other provisions of the sections. Accordingly, assessee contended that the capital of Rs. 4,19,85,805/- should be treated as long term-capital-gain and not short term.
Addition on account of revaluation of reserve
The AO observed that assessee has reduced an amount of Rs. 6,80,317/- on account of transfer from revaluation reserve, from the book profit. This revaluation is allowed to be reduced from the book profit of the year, when the said provision was made, and has been increased by these reserve or provision as per the proviso to sub-clause (i) under Explanation to section 115JB(2). The AO observed that since no details or brief has filed therefore it is not allowed as deduction.
Contention of the Assessee
Disallowance u/s 14A
The ld counsel of the assessee submitted that though CIT(A) has not mentioned about Rule 8D while making the enhancement, however, his method is exactly similar to the formula prescribed in Rule 8D which is untenable in law for the period prior to 2008-09. She further submitted that so far as the interest disallowance is concerned, the same cannot be made in the case of the assessee, because the investments which have yielded exempt income were made out of assessee’s own funds and which fact has been accepted by the AO not only in this year but also by the AO and CIT(A) in the earlier years.
The Tribunal in assessee’s own case for the AY 1999-2000 has noted the fact that investments were made at Rs. 39.02 crores, whereas, the assessee’s own funds were more than Rs. 85.5 crores. In AY 200203, no disallowance of interest was made and this fact has been accepted till the stage of the Tribunal. In any case, now this issue stands covered by decision of jurisdictional High Court in the case of CIT vs HDFC Bank, 366 ITR 505 and Delhi High Court in the case of Taikisha Engineering, 370 ITR 338.
Addition on account of transfer pricing adjustment
The ld counsel of the assessee submitted that first of all, the internal comparability resorted by TPO and confirmed by CIT(A) is incorrect on facts and also under the transfer pricing regulation given in Rule 10B. The two transactions with the AE cannot be compared, because both are controlled transactions and any comparability for benchmarking arm’s length price has to be done by uncontrolled transactions. Thus, she submitted that entire determination of arm’s length price submitted by the AO is erroneous. She further submitted that external comparables, as submitted by the assessee should be adopted and in case of L & T, the same has held to be a good comparable in the earlier year, which has been upheld by the Tribunal also, therefore, TPO should be directed to accept the assessee’s external comparables.
Computation of long-term-capital-gain
The ld counsel of the assessee strongly relied upon, the decision of ITAT Mumbai Bench in the case of Smita Conductors Ltd. vs ACIT reported in [2015] 152 ITD 417 wherein the decision of Hon’ble Bombay High Court in the case of S A Builders Ltd. has been relied upon.
Contention of the Revenue
Disallowance u/s 14A
The ld counsel of the revenue submitted that the Ld. CIT(A) has only tried to work out a reasonable basis for disallowance for which he has taken a same clue from formula laid down in Rule 8D. It is the onus of the assessee to prove the nexus between the investment made and interest free funds and also the expenditures debited in the P&L Account. In support of his contention he relied upon the decision of Delhi High Court in the case of Maxbopp Investments, 347 ITR 272 and drew our specific attention to para 24 & 25 of the judgment.
Addition on account of transfer pricing adjustment
The ld counsel of the revenue submitted that it is not in dispute that Resale Price Method (RPM) should be adopted and PLI should be the gross margin. If there are no internal comparables having uncontrolled transactions then matter should be restored back to the file of the TPO for carrying out fresh comparability analysis by selecting external comparables, to benchmark the gross margins.
Computation of long-term-capital-gain
The ld counsel of the revenue submitted that section 50 is non obstinate clause wherein it is deemed that an asset, which was part of the block of asset is deemed to be short-term-capital-gain. Thus, it has to be treated as short-term-capital-gain.
Held by CIT (A)
Disallowance u/s 14A
CIT (A) held that the assessee’s contention that no disallowance is called for cannot be accepted. Although he held that Rule 8D is not applicable, however, he proposed to make the disallowance by adopting the specified formula. CIT (A), worked out the disallowance as per the aforesaid method and accordingly, the disallowance was worked out to Rs. 3,25,89,130/- and thereby, enhancement of disallowance u/s 14A was made at Rs. 3,15,90,756/-.
Disallowance of professional fees
CIT (A) rejected the assessee’s contention on the ground that the expenditure has been incurred for getting the designs patented which adds to the value of the new asset which has an enduring benefit and accordingly, it is capital in nature.
Disallowance of various payments
The CIT(A) confirmed the additions on the ground that these payments were made by the assessee on account of error committed for non-compliance of certain regulations; interest for the delayed statutory payment and also penalty. Accordingly, such payments cannot be compensatory in nature but in the nature of infraction of law.
Disallowance of deduction of R & D expenses
CIT (A) dismissed the appeal of the assessee. It was held that the job of the auditors is to examine the facts of the case and given appropriate certificate and qualifications where ever required. The very fact that the auditors have mentioned NIL against the deduction allowable u/s 35 of the act, would mean that there is no such amount in the books of accounts of the appellant. Further but for submission as above, the appellant has not submitted details of capital expenses incurred by it, which would qualify for deduction under section 35 of the Act. Further the appellant has not even furnished any clarification from their auditors to this effect that they mentioned NIL against deduction u/s 35 for the reason that the appellant kept on hold the project due to huge losses incurred by the Appellant in earlier three years. Taking into consideration all the facts of the case, the action of the AO is considered justified and his action is upheld.
Addition on account of unutilized CENVAT credit
CIT (A) has directed the AO to make corresponding adjustment of CENVAT credit in the opening stock also in accordance with the decision of jurisdictional High Court in the case of CIT vs. Mahalakshmi Glass Works Private Limited, reported in 318 ITR 116.
Addition on account of transfer pricing adjustment
CIT (A), confirmed the action of the TPO on the ground that, firstly, the computation of gross profit submitted by the assessee has not found to be correct on facts and also as per the accounting practice; secondly, internal comparability resorted to by the TPO has not been disputed by the assessee and lastly, the assessee has not identified external comparability and therefore, the internal comparability resorted by the TPO is fully justified.
Addition on account of revaluation of reserve
CIT (A) uphold the action of the AO
Held by ITAT
Disallowance u/s 14A
It is clear that the formula adopted by the Ld. CIT(A) for making the disallowance u/s 14A is quite akin to formula laid down in Rule 8D which admittedly cannot be held to be applicable at all in the AY 2004-05. What could be the reasonable basis for disallowance has to be worked out from the nature of expenses debited and overall accounts of the assessee.
So far as disallowance of interest expenditure is concerned, in the case of the assessee it is an admitted fact, permeating from the earlier years that the investments which have yielded exempt income were out of assessee’s own funds and no interest bearing funds were diverted for making the investments. Once that is so, then in view of the ratio laid down by the Hon’ble jurisdictional High Court in the case of CIT vs HDFC Bank 366 ITR 505, we hold that no disallowance on account of interest can be made in this case. As regards direct expenses are concerned, the AO, has given a categorical finding which has not been rebutted before us, that Demat charges of Rs. 8,25,010/- were directly related to investment made in shares. Accordingly, so far as disallowance of Rs. 8,25,010/- on account of demat charges made by the AO, the same stands confirmed. Regarding balance disallowance, we find that 5% of the exempt income appears to be quite reasonable having regard to the nature of expenses and accounts of the assessee. Accordingly, we uphold the disallowance to the extent of Rs. 9,98,374/- which was made by the AO. Thus, ground no. A is treated as partly allowed.
Disallowance of professional fees
It is an undisputed fact that payment has been made for getting the engine designs patented, which the assessee produces/manufactures. Such a copyright and patent will only go to enhance the cost of such an intangible asset and accordingly, it has been rightly disallowed as capital expenditure by the Ld. AO and CIT(A). However, we agree with the alternate contention of the Ld. Counsel that if it is treated as capital expenditure for a capital asset then, depreciation has to be allowed on such an intangible asset, which specifically finds mention in section 32(1)(ii). Accordingly, we direct the AO to allow depreciation as per relevant rules provisions on such a capital expenditure. Accordingly, ground no. B is treated as partly allowed.
Disallowance of various payments
We find that so far as late payment of fee to Chennai Municipal Corporation is concerned it is on account of late payment of Health License, it is not for any kind of penalty or infraction of law. Accordingly, the payment made to Chennai Municipal Corporation is treated as business expenditure. As regards the payment on account of sales tax, it was due to technical error wherein assessee has stated that the destination of consignee as Indore despite the fact that name of consignee, destination and address were correctly written. This again cannot held to be in the nature of penalty or infraction of law. Next, amount of charges of Rs. 32,000/- for compliance of Weights and Measures is not for any violation which can be suggestive of any infringement of law, hence it cannot be held to be punitive in nature and accordingly, the same is held to be allowable. Lastly, as regard the amount paid to the High Court for sum of Rs. 10,00,000/-, this was on account of direction given by the High Court for granting Stay of demand on Company’s Stay Petition in respect of appeal filed before the High Court. The said direction for depositing the amount was to be allowed in the year where it will get adjusted against the demand. Accordingly, this payment cannot be held to be for any infraction of law or penalty. Accordingly, the same is treated as allowed. Thus ground D is treated as allowed.
Disallowance of deduction of R & D expenses
It is seen that assessee has taken a plea that it had incurred expenditure on research and development for developing a world class multipurpose engine for which it has embarked on “Avatar Project”, which got completed in AY 2007-08 and sample products were also tested. Since AO and CIT (A) have solely gone by the fact that that in the tax audit the amount under R & D has not been qualified therefore, in the interest of justice, we are of the opinion that this matter should go back to the file of the AO to verify the details of expenses incurred by the assessee and if the same are for R&D purpose, as claimed by the assessee, then the same should be allowed as deduction u/s 35(1)(iv). Accordingly, ground E is treated as allowed for statistical purposes.
Addition on account of unutilized CENVAT credit
We find that the Ld. CIT (A) has rightly directed the AO to make corresponding adjustment of CENVAT credit in the opening stock also in accordance with the decision of jurisdictional High Court. However, the CIT (A) has not referred to purchases made during the year as similar treatment has to be given for the purchases also. Accordingly, we direct the AO to give effect of adjustment in the purchases made during the year and work out the relief. Thus ground no. F is treated as partly allowed for statistical purposes.
Addition on account of transfer pricing adjustment
The transfer pricing adjustment has been made in relation to the import of spare part and equipments made from one AE, with the margin made from similar transaction with another AE. Thus, the comparability analysis as made by the AO/TPO and confirmed by CIT (A) by comparing two uncontrolled transactions cannot be sustained. Under the transfer pricing regulations, a comparability analysis is a comparison of a controlled transaction with uncontrolled transaction and they are comparable if none of the difference between transactions could effect the factors like price or margin. If there are some differences then a reasonable accurate adjustment can be made to eliminate the material effect of any such difference.
In this case, it is an undisputed fact that RPM should be adopted as Most Appropriate Method, wherein the gross margins i.e. gross profit over the sales are earned in the transactions are compared between the related and unrelated parties for the determination of arm’s length price. The TPO has carried out comparative analysis by adopting internal transactions with two AEs, which are completely controlled and related party transactions, hence, such a comparability analysis at the threshold is liable to be rejected. Accordingly, the entire approach of the TPO as well as CIT(A) is rejected because appropriate comparison has to be made from comparable uncontrolled transaction with the third parties, if there are no uncontrolled internal transaction.
Since the TPO as well as CIT (A) has not carried out any comparability analysis vis-à-vis these external comparables, therefore, in the interest of justice, we are of the opinion this matter should be restored back to the file of the TPO/AO for examining the three external comparables and complete gross profit margin for benchmarking the assessee’s gross profit margin in the import transaction carried out by the assessee with its AE. Accordingly, ground no. H is treated as partly allowed for statistical purposes.
Computation of long-term-capital-gain
The deeming provisions as contained in section 50 is to be restricted only to the computation of capital gain, as held by Hon’ble Bombay High Court in the case of Ace Builders Pvt Ltd. Further, in the case of Smita Conductors Ltd., the Tribunal held that for the purpose of computation of capital gain, the flat has to be treated a short term capital gain u/s 50 of the IT Act, but for the purpose of applicability of tax rate it has to be treated as long term capital gain if held for more than three years. We accordingly direct the AO to compute the capital gain from the sale of flat and apply the appropriate tax rate after necessary verification in the light of observations made in this order.
Accordingly, on similar line we direct the AO to compute the capital gain from sale of flat and apply appropriate tax rate. Accordingly, ground no. J should be treated as allowed.
Addition on account of revaluation of reserve
It is seen that depreciation of Rs. 16,10,62,604/- has been reduced by the amount transferred from revaluation reserve and only the net depreciation has been debited i.e. Rs. 6,80,317/- and accordingly, this net depreciation which has been transferred and reduced from revaluation reserve credited to the P&L account, ought to be excluded. Accordingly, AO is directed to reduce the net amount of Rs. 6,80,317/- on account of depreciation from the book profit in view of Explanation (i) to section 115JB(2). Thus, ground no. I is treated as allowed.
Accordingly, in the result the appeal of the assessee is partly allowed.
